Crypto R.I.P.?

Three and a half months ago, the hard-working staff here at Spoiler Alerts wrote a column about cryptocurrencies. I was, to put it gently, bearish: "One rule of thumb I have for asset bubbles is that if celebrities start getting in on the game, it might be time for the smart money to get out.

Already some celebrities are being sued for promoting cryptocurrencies that turned out to be classic 'pump and dump' Ponzi schemes. This suggests that while crypto will not disappear, we have reached the bubble phase."

A quarter of a year later I'm sure everything has stabilized - wait, what does this New York Times story from last week say?

The decline of crypto echoes the decline in other risky asset classes like tech stocks - except, as the financial press has noted repeatedly, the crypto declines have been far more acute than even the recent losses in the S&P 500.

What is particularly damning about the recent crash is that an awful lot of tech boys who talked up crypto made the argument that cryptocurrencies were an excellent hedge against inflation. Inflation has undeniably increased over the past year and, well, that is when crypto crashed.

As the Financial Times' Scott Chipolina and Katie Martin noted, "Their performance has undermined claims that crypto assets can provide a hedge against inflation or behave as a form of digital gold - let alone the grander boasts of crypto partisans about the potential for digital tokens to become the pillar of a new global financial system."

Furthermore, in an eerie echo of the 2008 financial crisis, one of the triggers for the market meltdown occurred when a comparatively "safe" investment - money market funds in 2008, stablecoins in 2022 - failed to be safe. Oops.

As a crypto-skeptic, it is tempting just go all Nelson Muntz on this situation. That would be uncharitable. Rather, it is worth considering whether the 2008 comparisons will go deeper. Can the collapse of crypto presage another financial crisis? This seems unlikely. The aggregate size of cryptocurrency markets is simply not large enough to lead to a general liquidity or solvency crisis.

Instead, the crises are real but more specific. El Salvador provides an excellent cautionary tale for other countries in the Global South. Last September, Salvadoran president Nayib Bukele announced that Bitcoin would be accepted as legal tender. A month later he announced that his government had purchased $25 million in Bitcoin. He persisted in embracing crypto despite warnings from bond rating agencies and the International Monetary Fund that this was a risky strategy.

Now El Salvador is in some financial trouble. El Pais reports that Salvadoran bonds are only trading at 40% of face value. Bitcoin has dropped more than 44% in value from the start of Salvadoran purchases, equal to their next bond payment.

According to Bloomberg, "Bukele, a devout believer in cryptocurrencies … has been trying for more than five months to sell a Bitcoin-backed bond. But investors have soured on El Salvador's bonds, concerned not only with the government's ability to keep current on its debt but its willingness to do so." One does wonder whether voters will start asking why Bukele is purchasing Bitcoin rather than spending on things like schools or roads.

Another crisis will be the late entrants to crypto who cannot afford to ride out the market gyrations. Retail purchasers of crypto made their choice based on horribly skewed information. They are now paying the price for doing so.

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What, if anything, will the government do in response? One has to expect that some regulation is coming. While cryptocurrencies have largely lobbied to advance their libertarian beliefs, it is striking how the crisis is causing some of them to embrace New Deal financial regulation.

Crypto has suffered crashes like this before. Boosters like Elon Musk and Jack Dorsey will probably be fine. Plutocrats sitting on billions of dollars possess the most valuable financial asset ever: the time and cushion to ride out vicissitudes in capital markets. This crash, however, will probably thwart their preferred outcome - more widespread acceptance of crypto in the financial markets - for quite some time.

The hidden upside: celebrities will finally shut up about crypto.

(COMMENT, BELOW)

Drezner is a professor of international politics at the Fletcher School of Law and Diplomacy at Tufts University.

Previously:
• 05/09/22: Biden's loose lips on Ukraine
• 04/13/22: Russia's Potemkin power
• 01/19/22: My scary love of Jewish horror
• 08/17/21:The analogy between Vietnam and Afghanistan is easy --- and facile
• 06/03/21: The peculiar pandemic pleasures of 'Madam Secretary'
• 07/30/20:Let's all talk about gold, yet again
• 03/31/20: The most counterintuitive prediction about world politics and the coronavirus
• 03/06/20: It turns out anti-populism is pretty popular
• 07/09/19: Everything you wanted to know about the international implications of zombie pig invasions but were afraid to ask
• 04/19/19: No one tell my mother about this column
• 04/04/19: The biggest strategic misread in Washington is about the other great powers
• 04/01/19: A nemesis is fine. A good news friend is better
• 02/26/19: Why I'm starting to worry about the dollar
• 02/05/18: Why I'll continue to watch the Super Bowl
• 01/17/18: The good news about Hawaii's false alarm
• 08/08/17: Princess Leia, PhD
• 12/05/16: The Orwellian nightmare for policy wonks is coming
• 09/20/16: Could the erosion of trust in government be at an end?
• 08/24/16: HUH!? Grad students at private universities can now unionize
• 08/23/16: What is it about Henry Kissinger?
• 08/09/16: A Very Important Column about . . . cargo shorts
• 07/04/16: 2016 is a fascinating year for politics, and that's awful news for political scientists
• 06/02/16: The twilight of the 'West Wing' economy?
• 05/20/16: A very important column about . . . the global governance of superheroes
• 05/12/16: Why Trump seems invulnerable to the flip-flop charge
• 05/11/16: Confessions of a Luddite professor
• 03/29/16: The trouble with writing about Donald Trump
• 02/29/16: Nobody will admit to the real reason Donald Trump is winning