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What’s all this about a crypto crash?

#crypto #finance #investing May 23, 2022

What’s all this about a crypto crash?

Are you a true believer in the cryptocurrency craze? A dubious observer wondering if it’s a scam? Or a completely baffled bystander wondering what the hell crypto even means?

Wherever you stand on the spectrum, it’s fair to say crypto has captured the attention of the investment world, with all its confusing jargon like ‘blockchain’ and ‘distributed ledger’. And it’s been in the headlines recently following a big slide in the value of most crypto currencies. 

So, before we dive into work out what happened and what it means, let’s pause for a moment on the basics. 

What is a cryptocurrency?

Well it’s kind of complicated, so let’s ask our favourite friends at Investopedia for a summary:

“A cryptocurrency is a digital or virtual currency that is secured by cryptography, which makes it nearly impossible to counterfeit or double-spend. Many cryptocurrencies are decentralized networks based on blockchain technology—a distributed ledger enforced by a disparate network of computers.” 

The best-known types of currency are Bitcoin and Ethereum – it’s kind of like the US Dollar or the Euro, except they don’t belong to any country. There are also lots of smaller, random ones like Dogecoin, which is quite literally based on a meme of this dog:

The thing to note here is that there is no actual, physical asset anywhere in these currencies. You can invest in real companies with real products on the stock market, or you can buy real houses with real tenants in the property sector. But there is nothing in the crypto world that you can actually put your hands on. 

This is one reason for their volatile value. Without an actual, tangible asset in sight, crypto is only worth what people decide it’s worth. And that sentiment can vary wildly from day to day, or week to week. 

What caused the crash?

Because of their inherent volatility, when crypto is going up in value, its supporters love to talk about the benefits of the asset class, and why it’s the key to the future. 

Indeed, there is exciting potential behind the blockchain technology that underpins crypto. It also represents the idea of ‘decentralised finance’, which is a kind of revolutionary ‘power to the people’ concept that may reshape investments in the future. 

But that’s the good news. The less positive news is that it’s a brand new concept, with a huge number of players – some are just normal business people, some are geniuses and some are just hucksters trying to make a buck (or should we say, make a dogecoin).

And the ecosystem they have set up is entirely new – it’s a huge experiment. Whereas the daggy old stockmarket has had over a century and a half to sort its stuff out, the crypto world has had just a hot moment.

It’s pretty technical, but basically the crash happened when one currency, Terra, was meant to be a ‘stablecoin’ that’s pegged to the US Dollar. But it didn’t … stay pegged. It dropped in value along with its sister currency Luna, and they ended up tumbling to about one-fifth of their value. 

This set off a bit of a panic across the whole asset class. As The Conversation explained:

“Once this was noticed, it caused panic, which in turn sparked market withdrawals, which then caused further panic. Some (but not all) stablecoins rely to a large extent on perception and confidence – and once this is shaken, big falls can come into effect.”

What does this mean for investors?

Without a tangible asset behind these currencies, it’s hard for anyone to say if their fall in value is justified. For crypto true-believers, it’s just having a tough time, and price volatility is part of life in a publicly traded asset – the same as the share market, with all its gyrations. 

For the non-believers, the crash in value is evidence that the whole thing is a house of cards, and this is the first card being pulled out of that flimsy structure. 

Perhaps the truth is somewhere in between. Nobody should be putting all their money into crypto - or shares, or property, or whatever for that matter. Diversification is the key to spreading risk and minimising losses. And crypto definitely sits at the riskier end of the investing spectrum, unproven and experimental as it is. 

But it could be the start of a compelling new world of investing, and some people are happy to take the risk to ensure they get in on the ground floor.

Whether or not you want to dip your toe into the water, education is key. Get yourself acquainted with the concept and all its jargon. Be sceptical of those promising a get-rich-quick future. And ignore the crypto-bro’s who act like there is literally nothing else on earth worth buying. 

Regardless of whether an investment is new, old or inspired by a dog meme, the same rules apply: you need time on your side to smooth out volatility; spreading risk is crucial; and if it sounds too good to be true, it probably is.

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