Cryptocurrencies melt down in a ‘perfect storm’ of fear and panic

The crypto world went into a full meltdown this week in a sell-off that graphically illustrated the risks of the experimental and unregulated digital currencies. Even as celebrities such as Kim Kardashian and tech moguls like Elon Musk have talked up crypto, the accelerating declines of virtual currencies like bitcoin and ether show that, in some cases, two years of financial gains can disappear overnight.

The moment of panic amounted to the worst reset in cryptocurrencies since bitcoin plummeted 80% in 2018. But this time, the falling prices have broader impact because more people and institutions hold the currencies. Critics said the collapse was long overdue, while some traders compared the alarm and fear to the start of the 2008 financial crisis.

“This is like the perfect storm,” said Dan Dolev, an analyst who covers crypto companies and financial technology at the Mizuho Group.

During the coronavirus pandemic, people have flooded into virtual currencies, with 16% of Americans now owning some, up from 1% in 2015, according to a Pew Research Center survey. Big banks like Northern Trust and Bank of America also streamed in, along with hedge funds, some using debt to further juice their crypto bets.

Early investors are still probably in a comfortable position. But the rapid declines this week have been especially acute for investors who bought cryptocurrencies when prices surged last year.

The fall in cryptocurrencies is part of a broader pullback from risky assets, spurred by rising interest rates, inflation and economic uncertainty caused by Russia’s invasion of Ukraine. Those factors have compounded a so-called pandemic hangover that began as life started returning to normal in the United States, hurting the stock prices of companies like Zoom and Netflix that thrived during lockdowns.

But crypto’s decline is more severe than the broader plunge in the stock market. While the S&P 500 is down 18% so far this year, bitcoin’s price has dropped 40% in the same period. In the last five days alone, bitcoin has tumbled 20%, compared with a 5% decline in the S&P 500.

How long crypto’s collapse might last is unclear. Cryptocurrency prices have typically rebounded from major losses, though in some cases it took several years to reach new heights.

“It’s hard to say, ‘Is this Lehman Brothers?'” said Charles Cascarilla, a founder of the blockchain company Paxos, referring to the financial services firm that went bankrupt at the start of the 2008 financial crisis. “We’re going to need some more time to figure it out. You can’t respond at this type of speed.”

The origins of cryptocurrencies trace back to 2008, when a shadowy figure calling himself Satoshi Nakamoto created bitcoin. The virtual currency was portrayed as a decentralized alternative to the traditional financial system. Rather than relying on gatekeepers like banks to facilitate commerce, bitcoin proponents preferred to conduct transactions among themselves, recording each one on a shared ledger called a blockchain.

Prominent tech leaders including Musk, Jack Dorsey, a founder of Twitter, and Marc Andreessen, an investor, embraced the technology as it grew from a novel curiosity into a cultlike movement. The value of cryptocurrencies exploded, minting a new class of crypto billionaires. Other forms of cryptocurrency, including ether and dogecoin, captured the public’s attention, particularly in the pandemic, when excess cash in the financial system led people to day trade for entertainment.

Cryptocurrency prices reached a peak late last year and have since slid as fears over the economy grew. But the meltdown gathered momentum this week when TerraUSD, a stablecoin, imploded. Stablecoins, which are meant to be a more reliable means of exchange, are typically pegged to a stable asset such as the U.S. dollar and are intended not to fluctuate in value. Many traders use them to buy other cryptocurrencies.

TerraUSD had the backing of credible venture capital firms, including Arrington Capital and Lightspeed Venture Partners, which invested tens of millions of dollars to fund crypto projects built on the currency. That gave “a false sense of security to people who might not otherwise know about these things,” said Kathleen Breitman, one of the founders of Tezos, a crypto platform.

But TerraUSD was not backed by cash, treasuries or other traditional assets. Instead, it derived its supposed stability from algorithms that linked its value to a sister cryptocurrency called luna.

This week, luna lost almost its entire value. That immediately had a knock-on effect on TerraUSD, which fell to a low of 23 cents Wednesday. As investors panicked, tether, the most popular stablecoin and a linchpin of crypto trading, also wavered from its own $1 peg. Tether fell as low as 95 cents before recovering. (Tether is backed by cash and other traditional assets.)

The volatility quickly drew attention in Washington, where stablecoins have been on regulators’ radar. Last fall, the Treasury Department issued a report calling on Congress to devise rules for the stablecoin ecosystem.

“We really need a regulatory framework,” Treasury Secretary Janet Yellen said at a congressional hearing Thursday. “In the last couple of days, we’ve had a real-life demonstration of the risks.”

Stablecoins “present the same kinds of risks that we have known for centuries in connection with bank runs,” she added.

Other parts of the crypto ecosystem soured at the same time. On Tuesday, Coinbase, one of the largest cryptocurrency exchanges, reported a $430 million quarterly loss and said it had lost more than 2 million active users. The company’s stock price has plunged 82% since its triumphant market debut in April 2021.

Brian Armstrong, Coinbase’s CEO, tried to reassure customers on Twitter that the company was not in danger of going bankrupt after a required legal disclosure about the ownership of its assets stoked panic.

Cryptocurrency prices also dropped precipitously. The price of bitcoin fell as low as $26,000 on Thursday, down 60% from its peak in November, before rising somewhat. Since the start of the year, bitcoin’s price movement has closely mirrored that of the Nasdaq, a benchmark that’s heavily weighted toward technology stocks, suggesting that investors are treating it like any other risk asset.

The price of ether plunged, too, losing more than 30% of its value over the last week. Other cryptocurrencies, like solana and cardano, are also down.

Any panic might be overblown, some analysts said. A study by Mizuho showed that the average bitcoin owner on Coinbase would not lose money until the digital currency’s price sank below $21,000. That, according to Dolev, is where a true death spiral could occur.

“Bitcoin was working as long as no one lost money,” he said. “Once it gets back to those levels, that’s sort of the ‘Oh, my God’ moment.”

Professional investors who have weathered past crypto volatility also stayed calm. Hunter Horsley, CEO of Bitwise Asset Management, which provides crypto investing services to 1,000 financial advisers, met with more than 70 of them this week to discuss the market. Many were not selling, he said, because every other asset was down, too. Some were even trying to capitalize on the drop.

“Their standpoint is, ‘This is no fun, but there is nowhere to hide,'” he said.

Still, the plummeting prices have rattled crypto traders. Just a few months ago, blockchain proponents were predicting that bitcoin’s price could rise as high as $100,000 this year.

“I never thought things would get ugly this fast,” said Ed Moya, a crypto analyst at the trading firm Oanda.