You might have been quietly confident that investing US$122 in the cryptocurrency Luna a month ago was a wise decision. However, Luna’s worth has plummeted since then.
Luna was far from the only victim of a week that saw cryptocurrency prices plummet by 30%. Some have recovered to some extent, but the market has lost over US$500 million in just seven days, raising existential questions about the market’s future.
A financial “attack” on the stablecoin Terra (UST), which is supposed to match the US dollar but is currently trading at just 18 cents, may have triggered the crash. Luna, its partner coin, has since collapsed.
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This type of attack is extremely complex, and it entails placing multiple trades in the crypto market in order to trigger specific effects – which can result in significant gains for the “attacker.”
In this particular instance, the trades caused Terra to fall, which in turn caused Luna to fall as well. When this was discovered, it sparked panic, which sparked market withdrawals, which sparked even more panic. Some (but not all) stablecoins rely heavily on perception and confidence, and when these are shaken, large drops can occur.
Importantly, the recent sharp drops in cryptocurrency prices have cast doubt on the stability of stablecoins. After all, by maintaining a “peg” to another underlying asset, they are designed to have virtually zero volatility.
However, the effects seen this week spread throughout the crypto space, resulting in single-day losses comparable to – if not worse than – a “Black Wednesday” (The term refers to the 16th of September 1992, when the pound sterling crashed, forcing Britain to exit the European Exchange Rate System (ERM)) for crypto.
Even the most popular stablecoin, Tether, has lost its peg, falling to 95 cents on the dollar, highlighting the need for regulation. Where is crypto’s safe haven if stablecoins aren’t stable?
Crypto confidence
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The reaction of investors will determine the future of cryptocurrencies. Panic and despair have already set in, with some comparing this crash to a traditional bank run. Customers are more concerned about their bank being unable to give them their money during bank runs than they are about their money becoming worthless.
A better analogy would be stock market crashes, where investors are concerned that the stocks and shares they own will soon be worthless.
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And, based on the reaction to the crypto crash thus far, it appears that a sizable portion of crypto investors share this viewpoint.
Regardless of historical price volatility, there is a common assumption in investor behavior: that the asset price will rise and continue to rise. The investor does not want to miss out in this situation. They see the asset rising in value, think it’s a “sure thing,” and invest.
Following initial successes, the investor may decide to invest more. When you add in social media and the fear of missing out on “inevitable” gains, you have a recipe for continued investment.
Simply put, many people will have invested in cryptocurrencies in the hopes of becoming richer. This conviction has undoubtedly been shattered.
Another reason to invest in cryptocurrencies could be a belief in their transformative potential, or the belief that they will eventually replace traditional forms of financial exchange.
We can better understand the behaviors we’re seeing if we think of cryptocurrency investors as different groups with different motivations.
Investors can take solace in the fact that the worst of the crash may have passed and that better times are on the way. But, as any financial adviser will tell you, nothing is guaranteed in crypto or any other market.
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