Crypto markets tumble and investors get their fingers burned

People who put their hard-earned cashinto atumbling cryptocurrencyunit that is at the heart of the latest sharp decline in digital coinsmay be regretting they did not read a recent paper by Canadian financial technology scholar Ryan Clements demonstratingwhy it was bound to fail.

In fact, all investors who have piled into any crypto assets since the end of 2020 and have not already sold may be feeling remorse for failing to take Clements's comments in my last column on cryptocurrencyas a word to the wise. Most will be deeply under water: In other words, their investments will be worth a lot less than they paid for them.

"I'm not sure ... that people knew what they were getting themselves into," Clements said on Thursday as he surveyed the damage on his computerscreen.

Trillion-dollar losses

Now, other financial commentators are echoing his warning that this time, the loss of more than a trillion U.S. dollars in asset value from world cryptocurrency marketswill have an impact well beyond the "crypto bros" who put in their own money.

Clements, a securitieslawyer who now teaches at the University of Calgary and advises Canadian securities regulators, saidthat does not mean the most popularcrypto assets may not rise again. They have done it before.

But as Canadianswho still hold a stake wait to see what Friday the 13thwill do for asset values, Clements saidthe past week's crypto sell-off has settled a few questions. One is whether, like gold, the limited supply of the most important cryptocurrenciesmeans they are a hedge against inflation or against the decline of other risk assets. We now know they are not.

Asinflation has climbed and markets have declined,even the best-known crypto token, bitcoin, was trading down nearly two-thirds from its peak of $69,000 in November of last year.

"Crypto assets are risk assets, they're not stable assets, they're not stores of value," Clements said. "And so that's why we're seeing a general market sell-off."

Anyone who took the advice of film star Matt Damon last October "Fortune favours the brave" in his promotional video for Singapore-based Crypto.commay be lamenting their courage.

Unstable stablecoins

Perhaps ironically, one of the destabilizing features of the current crypto decline this time is related to what are known as "stablecoins," which despite their name have put the entire market on edge.

As London's Financial Times warned on Thursday, another differencethis time is that traditional markets could suffer from the crypto meltdown.

"Unfortunately, even those fund managers in normal markets like stocks and bonds who have studiously avoided focusing on this freewheeling asset class need to pay attention," wrotethe paper's markets editor, Katie Martin.

There were reports on Thursdaythat El Salvador, which has accepted bitcoin as legal tender, had lost$40 million US enough for the cash-strapped Central American countryto cover its next bond payment and credit rating agencies warn of an increased risk of default.

Already, on Thursday,conventional market shares of the companyCoinbase, whichruns aplatform for trading digital tokens, had lost half their value on the week. And as Canadians tally up their bitcoin losses or sell to escape further losses, they don't feel so rich anymore.

"Any time there is massive selling in a segment of the market, there can be flight to safety and a cascadeof selling across other assets," Clements said, describing potential contagion that can lead to systemic risk.

An example of contagion is the sharp decline in terra, one of the so-called stablecoinsthat, unlike other kinds of cryptocurrency,aren'tsupposed to rise and fall but should stay pegged to the U.S. dollar, to be used as a dollar substitute on digitized global markets.

'Catastrophic failure'

On Thursday, terra was "officially halted" for two hours, said the company, Terraform, whichruns the crypto unit's blockchainthe software that sets a cryptocurrency's value and reveals who owns each of the units.Beforeactivitywas halted, the value of the unit had plummeted as low as 23 cents.

It was terra that Clementswarned about in a widely quotedpapertitled Built to Fail, which focuses specifically on what are called "algorithmic stablecoins" of which terra is the most important example and of which he predicted faced catastrophe.

"Its catastrophic failure, I think, has contributed to the larger crypto sell-off," Clementssaid.

He is not the only onewho takes that view, nor is Clements the only one who thinks some cryptocurrency units could eventually rebound. But he sees more potential trouble ahead.

WATCH | Conservative candidates take aim at Pierre Poilievre for stance on bitcoin:

Conservative candidates take aim at Pierre Poilievre for his stance on bitcoin

2 years ago

Duration 5:21

Conservative leadership candidates Jean Charest and Leslyn Lewis accused Pierre Poilievre of encouraging Canadians to invest in the digital currency.

Now that the tokens have shown themselves not to be an inflation hedge, a major justification for holding themas outlined to me earlier this year by Henry Kim of York University's Schulich School of Business may have disappeared. As a risk asset, not money or an innate store of value, crypto should perform more like tech stocksbut without any underlying income, falling as inflation and interest rates rise.

Sharper declines could lead to forced sales for those who have borrowed to buy. Clements is convinced some of the19,419crypto examples now listed on CoinMarketCapwill fall to zero or worse. He also fears some crypto examples will prove to beblatant frauds.

Clements says that as crypto units test new lows, now may bethe time to reassess the purpose and value of cryptocurrencyand the energy-intensive global software that keeps them all alive.

"I think it's a neat time in the market to find out what is the true utility in blockchain," he said. "Other thanjust crypto for the purpose of speculative trading."

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