Surveilled #81 – is the 2022 crypto crash an ending or a beginning?
Back in December of 2017, my fellow commuters on the bus to work were glued to their phones, looking at the balance of their crypto portfolios and excitedly texting their friends about how to spend the money. Almost exactly a year later, Bitcoin reached a trough, having dropped more than 80% over the period. Since then, the pattern has repeated, with the latest run up in prices really taking off in the second half of 2020, and now ending again in a crash, with Bitcoin down 66% from the peak to date.
The question now is, are we in a situation similar to 2018, and are crypto markets taking a momentary break before another huge run-up, or is there something more fundamental going on? The problem is that the term “crypto” covers many things, all with differing degrees of emotional investment on behalf of proponents and opponents, and the answers tend to break down along these lines.
First, and most narrowly, crypto refers to the tokens like Bitcoin, Ethereum or Tether that are traded like a commodity. Right from the start in 2008, crypto tokens were extolled as a form of gold, a hedge for inflation, and an asset independent of the vagaries of central banks around the globe. By extension, the tokens are positioned as the foundation for a new model of financial intermediation (or rather, lack thereof) known as Decentralised Finance (DeFi), that could replace our existing financial infrastructure.
Unfortunately, the arrival this year of inflation levels not seen in decades and the war in Ukraine triggered turmoil in financial markets comparable to that of the global financial crisis (GFC) in 2008, and put the new models enabled by crypto to their most severe test yet. So far it seems they have conclusively failed. Most crypto tokens, rather than being a hedge against inflation, moved in exactly the same direction as other risky assets. Investors have lost a lot of money, and high-profile bankruptcies of crypto funds, exchanges, lenders etc. have begun. The dysfunctions of the market have also become apparent, with even the largest exchanges suspending withdrawals of some tokens because of an inability to keep up with trading volumes and a lack of liquidity. Not exactly confidence-enhancing signals.
The silver lining so far is that the financial world at large doesn’t seem to be threatened by the fallout, perhaps thanks to the more stringent regulations enacted after the GFC. But overall, it seems fair to say that crypto as a replacement for our current financial system failed its first test. Add to that intense scrutiny from regulators, with the EU announcing a relatively stringent set of rules, and it’s straightforward to conclude that our current financial system will be around for a while yet.
Second, and more importantly for the long term, crypto of course also refers to the set of technologies that underlie the tokens, and more broadly “web3”, which is supposed to supplant the “web 2.0” we currently live in. The ambitions of crypto technology are generally unimpeachable, at least for certain use cases: decentralised, transparent, immutable etc., and this is a key reason for the outsized interest in the field, my own included. There are a vast number of experiments ongoing, some more interesting than others of course, but there is no denying the creative energy in the sector, in part also because of the huge run up in prices that provide ample funding.
From this perspective, the relevant comparison is not 2022 vs 2018, but 2022 vs 2001 and the bursting of the dotcom bubble. In other words, will the current crash clear the way for the emergence of an all-conquering web3, or is it exposing more fundamental flaws?
The earliest implementations of crypto technology, for example proof-of-work chains, seem ill-fit for the times. Whereas concerns about climate change can be easily discounted because of the long time horizon, the spike in energy prices caused by the war in Ukraine threatens to make mining unprofitable today. Hopefully this will accelerate the switch to more environmentally-friendly models, at the very least, but that switch will not necessarily go smoothly, given existing investments in mining infrastructure.
More fundamentally, there still don’t appear to be use cases for which crypto technology is indispensable, and this despite all the experimentation that was enabled by the financial inflows over the last few years. That’s not to say that there’s no point to it. It may be possible to realise the same objectives through existing technology, but this ignores the social aspects of crypto, that are arguably more important than the technical aspects, exemplified by the open, permissionless blockchain.
Nonetheless, the crypto space appears to be at a critical juncture. It seems unlikely to me that the enthusiasm for the financial side of it will return as quickly as it did previously, also because of the wider macro-economic and geopolitical context. Perhaps a more constrained financial environment will spur a renewed bout of innovation (necessity is the mother of invention, as they say) that will firmly establish crypto and web3 as a valuable platform. But I wholeheartedly agree with Steve Randy Waldman, who lucidly argues that crypto and web3 will prove to be a sort of transitory step, where new ideas are explicitly positioned as antagonist to the current arrangements, before regulation and institutions catch up and integrate those new ways. What that means for the related financial valuations is honestly still anyone’s guess at this point.