My dear Friends,

there is much brouhaha in crypto markets right now, culminating in FTX’s shock bankruptcy declaration last Friday. So far, the global financial system remains unscathed, which is a relief.

Some speculate about crypto’s Lehman moment others see another Dot-Com crisis. As a reminder-the 2000 Dot Com crisis happened when after a massive growth (400% in five years), the market lost 78% of its value, and investors lost massive amounts of money.

The big question is, did investors miss important clues-there must have been plenty of red flags.

If investors really ignored essential clues, what were they?

Cryptonomy

It all started in November 2021; Bitcoin (BTC) had just reached its all-time high of $69.000. Shortly after, the upward momentum halted, and the currency lost a few percentage points. Nobody was worried yet.

Everybody knows the crypto market is volatile; after all, the market gained triple-digit percentage points between November 2020 and November 2021. Bitcoin’s (BTC) rise has been a staggering 360 per cent! So why worry?

Cryptocurrencies and tokens were on seemingly unstoppable upward trajectories. At one point, Dodge Coin rose by 800% in 24 hours because Elon Musk had publicly supported the currency in a Tweet. In 2021 Christie’s 3.0 – the auction house’s NFT section-sold tokens worth a total of $150 million, contributing to its $7.1 billion sales in the same year.

Sports and Hollywood celebrities had also gotten in on the fanfare – Kim Kardashian, Gwyneth Paltrow, Tom Brady, Matt Damon, Lionel Messi and Reese Whitherspoon, just to name a few.

Giselle Bündchen and her ex-husband Tom Brady had invested large parts of their Net Worth in FTX, Reese Witherspoon tweeted about her investment in Ethereum, and Paris Hilton publicly supported Bitcoin. “Honi soit qui mal y pense” – was it to pump their investments?

Crypto tumbling

In December 2021, Bitcoin’s (BTC) value fell sharply; however, it made good for some loss later. Probably the first indicator that the market was at a turning point. By the end of January, the sickly overinflated crypto bubble started to deflate seriously.

It was the beginning of a domino effect. Terra (LUNA) and TerraUSD (UST) experienced such steep declines that investors got spooked. The weak sentiment spread across the crypto market resulted in investors withdrawing their money, causing Tether (USDT) to lose its peg to the dollar. 

By July 2022, the crypto market was losing $600 billion weekly. Numerous crypto exchanges and currencies defaulted over the following months.

Some saw this coming; others claimed the crypto collapse was long overdue. Doomsters compared the alarm and fear to the start of the 2008 crisis– the famous Lehman moment.

A quick reminder: The collapse of Lehman Brothers was an exceptional event, with severe effects and dramatic consequences culminating in the global financial crisis of 2008. 

Fear of contagion was mounting. The very foundations of the crypto markets were in jeopardy. Bitcoin’s price plummeted to an annual low of $17,500, with a short rebound to around the $20,000 mark, only to fall back again. Yet, still above Bitcoin’s value at the beginning of 2020 – of $6,965.72. 

“The crypto ecosystem has been made fragile by leverage and interconnectedness, just as the traditional financial system was fragile because of leverage and interconnectedness in 2008,

Hilary Allen, Financial Regulation Expert, American University Washington College of Law

Crypto contagion

No longer the almost $3 trillion market(14.11.2021), by November 2022, the total market capitalization for crypto had fallen to $837 billion. Bitcoin (BTC) has lost about 63% of its value since the beginning of the year. The price had dropped below the $16,616( 14.11.2022)mark. 

Crypto’s most mainstream exchange, Coinbase, was feeling the winter. When the company went public in 2021, its stock opened at $381. Now it is under $60 amid the widespread crypto downturn. Coinbase reported quarterly results that fell far short of analyst estimates.

A “too big, too fail” Bahama registered exchange- with $14.6 billion in assets(June 20222)- prompted the latest drama in the sector.

FTX, the world’s second-largest cryptocurrency exchange, was in trouble. Rumours began circulating that Almeida, FTX’s trading platform, would have serious balance sheet issues. FTTs, tokens FTX had issued, were allegedly used as collateral to fill Almeida’s substantial financial hole. Consequently, rival Binance(Chinese) dumped its investment of 23 million FTX tokens(FTT). A total of $529 million. The next domino tile had fallen; others quickly followed.

Now, retail and institutional investors started withdrawing funds in a bank-run exodus. Within 72 hours, investors’ demand was for a total of $6 billion. FTX, previously valued at $34Billion, did not have this kind of liquidity, and finally, withdrawals had to be frozen.

In a rapid series of events, Binance offered a rescue package, only to retract shortly after- the final death blow for FTX.

This had dire consequences for the rest of the crypto market. $100 billion were swiped off the market within 24 hours. Within a week, the market had plunged 20%.

The Investor

A period of very low-interest rates, overly accommodative monetary policies and a rapidly developing FinTech sector created a new type of investor. Not only had investing become democratized, but user-friendly trading platforms fostered the gamification of investing.

These new-age investors seized the opportunity for easy gains and jumped into bitcoin, Ethereum, and numerous other currencies in varying flavours and utilities. Currencies were bought, tokens were invested in, and investors became wild traders- all the trademarks of an expectation bubble. And a new kind of economy was born – tokenomics.

Just a brief explanation, tokens are units representing an asset or utility in digital form. Literally, everybody can issue a token and pin a value to it. This value does not necessarily have to be attached to an actual or liquid asset. Once the token is put on the market, the issuer hopes someone out there will pay the price. Not a very reassuring rationale.

The fact is too many crypto investors are seriously overwhelmed by blockchain-specific terminology. The crypto community has a problem explaining itself, and investors don’t want to come across as idiots.

Instead, they made choices based on peer advice, investing bias or social media influencers. Investors gladly trusted the issuers’ knowledge and considered such technical details somewhat irrelevant to their own purpose, namely, to get rich quickly.

The stereotype

The reality

Crypto investors are any marketeer’s dream target group. Usually, 35-year-old men and married. Highly educated and affluent, with a median household income of $102K, tech-savvy and a very high tolerance for risk.

Statistically, more men are investing in crypto than women. 3% of male respondents owned one or more cryptocurrencies compared to only 0.8% of women. This gap had widened since 2017 when there was male/female parity.

Age is negatively associated with cryptocurrency ownership. In other words, when you get older, cryptos are less attractive. Cryptocurrency would therefore be primarily a “youth thing.

The Covid-19 newbee

During Covid lockdowns, people started working from home; some were bored, others suffered from a lack of social interaction, and plenty had rather existential fears.

How to secure retirement? How to invest? Will I be able to maintain my standard of living? Will my job still exist when this is over? All had one thing in common- lots of cash in their pockets, access to more cheap money and plenty of spare time. So, a new kind, often inexperienced and very young investor, entered the markets.

Supported by positive media, driven by FOMO, social media groups and the odd celebrity, this new breed expected rapid gains and got it for a while.

Crypto investor’s traits

” …there’s a lot of unregulated risk in crypto, so if you’re not a seasoned investor, you can get in trouble

Hunphrey Yang, Personal Finance expert, Humphrey Talks

Missed Clues

Crypto investors were enticed by stories of rags to riches and societal transformation through crypto trading. They tried to utilise leverage to multiply their returns and ride the token to the moon.

But there are other factors as well: a sense of belonging, being part of something superior and tech-savvy. What binds crypto investors together is an” us against the system” mindset and the idea of participating in the disruption of established systems.

Rules of investing

None of the above basic rules for investing was implemented by crypto aficionados. Investors-institutional and retail alike- succumbed to having wool pulled over their eyes. Everything seemed acceptable in pursuit of the transformative, the “visionary”, and abundant gains. Investors were bamboozled into businesses they did not understand.

Cryptocurrencies, it was claimed, are a good hedge against inflation that was just proven untrue. Another claim that the crypto idea is about being decentralized is a farce. A handful of interconnected “bright guys” who run interconnected businesses can not be labelled decentralized! Neither are cryptocurrencies a safe haven in case of market turbulence; this is a blatant lie. Over recent months the crypto markets have shown to be extremely sensitive to financial market turmoil – why? Because it is speculative and not fact-based.

The truth is, nobody dared to admit to not understanding what these business models were really about. Investors did not want to look like idiots and did not ask. The crypto community did not feel the need to further explain what it was up to.

Note-By

“The primary use of crypto is speculation, and so its failure is unlikely to have broader repercussions so long as the traditional financial system has no significant exposure to crypto,” 

Hilary Allen, Financial Regulation Expert, American University washington college of law

Speed- Read

By November 11th, 2022, the crypto market has lost more than $2 Trillion. FTX’s bankruptcy sent far the enormous shockwaves through the crypto markets.

Crypto investors are enticed by rags-to-riches stories and are prone to take high risks and make heuristic decisions.

Investors are generally overwhelmed by blockchain-specific terminology and blinded by the pursuit of the transformative and greed. Investors were more than naive and overlooked that many of the crypto business models did not make sense at all.

However, this does not mean the crypto market is dead. Not only will a “hold on against the system” mindset keep the system alive but hopefully, a new kind of crypto investor, one who will ask more questions.