With each passing day, the brave new world of cryptocurrencies is looking more like the perilous old world of Wall Street circa 1929 or 2008. Supposedly stable investments are proving to be anything but. Specialized hedge funds, exchanges and bank-like entities are imploding, having made highly leveraged bets with other people’s tokens. Trillions of dollars in virtual wealth have vanished.
The right response? Relief that things didn’t get even worse.
Rarely has a crisis been so well timed: Crypto managed to boom and crash before it became too connected to the broader financial system. The damage has been limited mostly to those who, despite ample warning, chose to get involved. There’s no need for emergency intervention. On the contrary, the bubble’s deflation, while it lasts, affords regulators and investors a unique opportunity to reflect and act on the lessons learned.
So what are those lessons? A few come to mind.
- Crypto is not an asset class. Stocks and bonds have cash flows. Commodities have industrial uses. Digital tokens have nothing but sentiment. Someday, they might prove useful as representations of assets, making transactions cheaper and more reliable. As things stand, buying them is pure speculation, not investment. They’re worth no more than you’re willing to lose, and certainly have no place in pension funds or retirement accounts.
- Don’t let the financial system get too exposed. If big banks had made a lot of crypto-backed loans with regular folks’ deposits, the crash would‘ve been a lot worse. Regulators have rightly leaned against this, and should move ahead with rules to ensure it doesn’t happen in the future. Officials should also limit the threat posed by stablecoins, digital tokens that purport to be worth a dollar. These should be backed by actual dollars held at the Federal Reserve, not by other crypto or by loans to traditional companies, so they won’t trigger panics or a real-world credit freeze.
- Don’t try to run an economy on the stuff. Of all the governments experimenting with crypto, El Salvador has probably gone farthest. It required businesses to accept Bitcoin, and sought to encourage adoption by offering $30 worth to anyone who would sign up for its (notoriously glitchy) crypto payment app. Most takers quickly spent the windfall and, quite sensibly, went back to using dollars. So far, the government has lost an estimated $59 million on the $106 million it spent on Bitcoin — small compared with annual revenue of about $8 billion. Still, it’s a cautionary tale: If President Nayib Bukele had succeeded in converting El Salvador to Bitcoin, as he had hoped, the country’s already ample financial challenges would be much more severe.
Perhaps the speculative frenzy surrounding crypto will eventually give way to the development of truly valuable applications, as happened with the internet. For the time being, though, better to keep a safe distance.
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