As markets have sold off, one segment that has been hit particularly hard so far is crypto. And if you thought the sell-off in the stock market was bad so far, just wait until you look at the numbers for crypto. The S&P 500’s price has dropped about 19.7% since the beginning of the year. In crypto, bitcoin is one of the best performers this year. It’s down 58.8%. There’s really no way to make that number seem any better than it is. It’s absolutely horrific. Other cryptos have done even worse. Ethereum is down 71.5%, for example. Many others are now at 100% losses.
So, what now? If you buy now, are you buying the low? Or is this the beginning of the end for crypto? First, let’s look at why you would invest in crypto. The thesis for crypto is that it is a store of value, it is digital gold, it is an inflation hedge, and it will be part of a new monetary system, disrupting our current legacy monetary system and leading to a surge in financial innovation. This thesis is why many believe that crypto prices will go higher and that buying into crypto is a good idea. Well, let’s look at how this thesis has played out so far. Is it a store of value? I don’t think so. I wouldn’t classify anything that loses more than 50% of its value in a few months as a store of value. Is it digital gold? At this point in its life, crypto is not acting very gold-like. Gold has been a valuable commodity for thousands of years. Crypto is struggling to retain its value after only a decade. At this point it has more in common with fool’s gold than the real stuff. Is it an inflation hedge? Well, we’re just now seeing inflation for the first time in several decades and crypto is tanking. If it’s an inflation hedge, it’s not a very good one. Will it be a part of a new monetary system? This one is yet to be determined, but so far it has not made any progress here, and with rival central bank digital currencies being a possibility it seems highly unlikely. We may see some value from financial innovation, but it is hard to know if that value will be captured by crypto investors as by its design crypto is not supposed to have its value captured by the middlemen investors.
The reasons for investing in crypto have clearly broken down. Additionally, the overall macroeconomic environment has shifted. Central banks around the world have tightened financial conditions in the hopes of staving off inflation. Money is getting tighter. When money gets tighter, speculative assets lose their edge over the assets that people need today. It turns out that the crypto space is much more speculative than its proponents advertised it to be. As soon as money tightened and the speculative fervor dissipated, crypto fell out of favor. Speculation has left and there’s a good chance speculation won’t be seeing its day in the sun again until financial conditions loosen up.
The “innovation” at this point has also been highly questionable. Two major crypto crashes in Luna and Celsius have shown that many crypto applications only work if new money keeps flowing into the system. This isn’t too unlike the normal monetary system, but a big difference is that the money can leave crypto anytime, and when it does, the system breaks. Our current monetary system could face the same challenge, but that’s why regulations and safeguards are put in place to prevent that from happening. With crypto, there are no regulations or safeguards. These events have also shown that the use cases for crypto aren’t any better than what we already have in place.
Now a bigger question comes from all of this – Are we going to experience a wider impact on the economy from the crypto crash? With many crypto investors now seeing massive losses, they will be experiencing a negative wealth effect. These losses are largely being felt by younger generations, millennials and younger. These younger generations typically make up the largest portion of spending in the economy, but if they lost much of their money in crypto, that may be a reason for spending to go down. This could be a contributor to lower consumer spending this year which would result in lower corporate earnings and put downward pressure on equities. Also, many of the crypto stablecoins use financial assets as collateral to support their value. If we see a big reduction in stablecoins, we may have a selloff in assets that are used as collateral. Combined, the negative effects may actually be somewhat minor, but it is definitely something to keep an eye on.
Reiterating what I said a year ago now – I have a high degree of confidence that at least 90% of crypto will end up being completely worthless and have no real use case. I also think that if there is a remaining 10% that could have a use case, it may end up not even being investable. By its design, the value in crypto is not supposed to be captured by asset owners. I continue to be weary of crypto, thinking it is more risk than reward. It appears to have fully devolved into the greater fool theory.
On the other hand, if you’re looking for an asset that’s a store of value and that has also shown to work as a hedge against inflation and other geopolitical risks, my bet is on the real gold rather than the fool’s digital gold. I continue to see gold favorably and expect the thousand-year uptrend to continue over the long-term.
