This week, the crypto market plummeted for the second time in a month, in tandem with a sharp drop in global stock markets. The collapse, not the first of its kind, showed again how the violent swings of a largely unregulated market warp the development of a transformative technology. But crypto is just one aspect of the larger blockchain universe. Its skeptics and fans alike must learn to see it as a technological experiment, instead of just a blatant scam or a speculative path to riches.
Why has the market fallen apart in such spectacular fashion?
The first recent crash, when the cryptocurrency market plunged 36 percent in a week in May, offers a clue. The collapse was largely set off by the death spiral of a cryptocurrency system called Terra Luna, made up of the coin Luna and its associated stablecoin, TerraUSD. At its dizzying heights in the spring, it represented roughly 3 percent of the total crypto market. Fear spread throughout the exchanges, and with it came panic selling.
After the second crash this week, the cryptocurrency market is still worth in total nearly $1 trillion (about one-third of last November’s peak). Only a few of the 19,000 cryptocurrencies that have been created since 2009 are now worth billions. Most have failed. The crypto market is wildly volatile not because of cryptocurrency’s underlying technology, but because of the uneasy and often dangerously unstable junction between emerging technologies and regular money. Viewed from the long perspective of market history, this instability isn’t remotely new.
In the late 1990s and early 2000s, internet stocks were a white-knuckle ride, just as crypto is now. Back then, too, hucksterism was rampant, the atmosphere was like a casino, and almost any idea with an “e” in front of it — no matter how reckless or silly — attracted attention from investors and the news media. Seemingly every day, fortunes were spectacularly made and lost.
But even as Napster, Webvan and eToys flamed out, a revolution was taking place. Despite all the shenanigans going on in the casino, real and lasting companies, publications and communities were built and thrived online. The internet survived, more or less.
Terraform Labs, the company behind TerraUSD and Luna, was founded in 2018 by Do Kwon, a computer scientist and entrepreneur in South Korea. Mr. Kwon, now 30, is a notoriously brazen hustler who has made waves for calling his critics “poor” and “cockroaches.” But despite his lack of polish, and the early warnings from developers and analysts about the technical weaknesses of his plans, he succeeded in raising $200 million in venture capital from 2018 to 2021. His company boasted of reaching an elusive goal in crypto, namely, the establishment of a truly “decentralized” stablecoin.
Stablecoins, which serve as a kind of bridge between crypto and ordinary money, have so far required vast amounts of old-fashioned real-world collateral to work, contrary to crypto’s original aim of eliminating reliance on legacy financial systems. Terra Luna was an algorithmic stablecoin system in which “stability” was supposedly guaranteed by mathematical mechanisms and incentives. Like those highflying early internet stocks, these, too, proved vulnerable when trust failed.
In the 2000s, the alchemists of collateralized debt obligations turned junk securities into AAA gold through the mathematical magic of “bundling.” The arcane mathematics underpinning algorithmic stablecoin systems like Terra Luna gave off the same captivatingly mysterious vibe. But when more and more borrowers defaulted, collateral debt obligations and other exotic derivatives — which Warren Buffett once called “financial weapons of mass destruction” — collapsed, contributing to the 2008 global financial crisis. Echoes of the destructive power of derivatives can be heard in the story of the equally exotic Terra Luna.
Risk like this can go unperceived for only so long. The sad thing is that when risk suddenly becomes manifest, it takes real people’s money and, often, good and promising projects down with it. Or even whole economies: Losses in the 2008 crash were estimated at more than $10 trillion in the United States alone — a sum that dwarfs the most destructive swings in crypto so far.
As Terra Luna’s death spiral accelerated, its supporters, known as “Lunatics,” lurched between terror and hope as Mr. Kwon shoveled more than $1 billion in Bitcoin into the system in an attempt to restore stability. “Deploying more capital — steady lads,” he tweeted.
But ultimately, there wasn’t enough cash coming in to make up for outflow, just as in an ordinary bank run, and this particular experiment in replacing trust with mathematics was at an end. Among the many thousands of failed crypto experiments, Terra Luna stands out as one of the largest, taking with it roughly $60 billion in total market value.
The vociferous opponents of crypto have been quick to celebrate the death of the blockchain, insisting that all crypto is fraudulent. These critics are a mirror image of the equally unrealistic cheerleaders at the opposite end of the spectrum: the pro-crypto libertarians clamoring for a financial world with no regulations whatsoever.
Responsible players in the crypto market have been calling for and helping to develop sensible regulatory frameworks for many years. A bedrock of crypto regulations already exists; in the United States, federal agencies such as the Financial Crimes Enforcement Network, the Securities and Exchange Commission and the Commodity Futures Trading Commission started weighing in on separate aspects of trade and taxation in 2013. In October, the Department of Justice announced the formation of the National Cryptocurrency Enforcement Team. The list of crypto scammers who have gone to jail already far surpasses the number of bankers jailed in the United States for their role in the 2008 financial crisis.
In the early days of the internet, the circus atmosphere made it easy to ignore the dangers that were brewing — surveillance capitalism and illegal government snooping among them — and that would have grave global consequences. In time, regulations were put in place: privacy frameworks, like some provisions of the 1999 Gramm-Leach-Bliley Act in the United States and the 2016 General Data Protection Regulation in Europe, and speech protections like Section 230 of the Communications Decency Act.
At the same time, the marvels of the internet multiplied, magic that by now seems unremarkable: a map of the world, street by street, in your pocket; instant translations from almost any language; a look-up service for every branch of knowledge; global, near-instantaneous news. Today’s internet is deeply woven into the world’s economies, media, politics, industry and social life, in good ways and bad.
A similar evolution is in the works for crypto. Blockchain, the technology that makes cryptocurrency possible, has the potential to be just as transformative as the internet innovations on which we depend every day, and industries like supply chain management, finance and pharma have already begun to find uses for it.
It’s possible to imagine a future where you might look up the fate of every tax dollar you’ve paid, and government corruption becomes all but impossible; where beautiful and important stories and music, games and art would never disappear from the internet; where, instead of being forced to rely on a big power company, you might buy and sell surplus solar energy from or to your own neighbors, and never face another blackout. Wherever tamper-proof, independent record-keeping is needed, blockchain could keep all the receipts, available and safe, for anyone to see.
But in order to make a world like that possible, crypto must be responsibly integrated into the existing global economy. Regulators, the media and market participants must get on the same page to balance the benefits of innovation against the need to prevent harm, and naked greed should be roundly chastised, not encouraged.
To many, the possibility of huge profits is the most interesting thing about crypto — it’s a gold rush in which anyone can suddenly become rich beyond his or her dreams. But the regrettable get-rich-quick mentality that has too long been associated with entrepreneurship, in crypto and elsewhere, must come to an end.
After all, just as most everyone keeps going to work whether the stock market is soaring or tanking, the practical, real-world work of developing blockchain technology will keep on going, independent of the histrionics of the market.
The New York Times
