Has The Crypto Balloon Popped?

Date: 12/14/2021
Author: Mr. X

Cryptocurrency collapsed to start the week, with Bitcoin falling beneath the psychologically important $48,000 marker. Bitcoin has fallen by more than 25% over the last month. Some of the alt-coins have fallen even more catastrophically with Cardano (ADA) down almost 40%, Polkadot (DOT) down more than 44%, and Uniswap (UNI) by almost 42%.

What could be behind this? There are several reasons.

First, Dr. Kent Moors pointed out what could be the root cause all the way back in July. There are real questions about the collateralization that backs the stablecoin Tether. Stablecoins are needed for just about every cryptocurrency exchange and are necessary for the emerging Decentralized Finance (DeFi) system. Without stablecoins that have sufficient collateral, we face a valuation crisis similar to that which gripped the real estate market in the United States in 2007-2008 and, on a smaller scale, in China today.

Second, regulators are circling DeFi and cryptocurrency generally, like hyenas preparing to attack a wounded animal. If stablecoin valuations are off, that provides the necessary justification for government control of cryptocurrency. There’s also the unanswered question about whether various tokens are coins count as “securities” and are therefore subject to scrutiny by the Securities and Exchange Commission.

Third, we have the rise of potential digital currencies that are being proposed by many countries. China is far ahead of the United States in this regard. Australia has proposed a licensing framework for cryptocurrency exchanges. However, unlike China, it is offering a carrot as well as a stick. There is some discussion about possibly linking crypto assets with a central bank digital currency (CBDC) in the country, which could conceivably provide security. This would solve the “stablecoin” problem and give security to investors who have been plagued by fraud and theft.

Fourth is the growth of that fraud and theft. The statistics here are truly staggering. So far, over $12 billion have been lost due to fraud, theft, and “exploits” of applications. The overwhelming majority has been criminal activity, albeit in an anarchic space where regaining lost property can be difficult. This can include classic “rug pull” moves – like announcing a new token based on the Ethereum blockchain, gathering ether (the cryptocurrency), and then simply dropping the project and running off with the money. Stealing passwords or using fishing links are also common. Yet the most troublesome problem lies in exploits of flawed code. If “code is law,” then using an exploit isn’t doing anything unethical. It’s survival of the fittest.

This is precisely what just happened with Solana (SOL). Solana is much faster than Ethereum and for that reason has developed what is arguably the most vibrant ecosystem within the cryptocurrency sector. However, it has suffered two major cyber attacks within the last three months. This comes at the same time that Fractal, a new NFT marketplace focused on gaming, has launched on Solana. Yet one of the most recent attacks rendered Solana completely unusable for about 17 hours.

Finally, there is simply something as old as markets. Cryptocurrency has been driven by speculative frenzy and may simply be due for a correction. Unlike stocks, bonds, or precious metals, cryptocurrency’s actual uses may seem bizarre or obscure. Many of those who are buying cryptocurrency are doing so through Robinhood [HOOD] or Coinbase [COIN]. In other words, they are using centralized exchanges, probably not setting up private wallets that they can use to use cryptocurrency directly or keep out of the control of others. Rather than serving as an alternative to the financial system, it’s just become another speculative asset within the existing cryptocurrency system. Of course, it doesn’t help that a couple cryptocurrency exchanges have also failed recently.

Not surprisingly, HOOD was down more than 2% yesterday. COIN was down by more than 1.7%.

The growth of DeFi, unlike traditional finance, is being driven by elaborate derivative instruments that many prosperous investors may simply not want to bother with. Given the rise in the omicron variant of COVID-19 (which may be more dangerous than some originally thought), the prospect of stagflation, and the almost certain move by the United States Federal Reserve to increase interest rates earlier than thought, the temptation is to withdraw any profits made over the last year and hunker down.

We should keep this in perspective. Bitcoin has lost a tremendous amount of value. Yet despite this historic decline, bitcoin was less than $30,000 per BTC, one year ago. Long term investors have not just enjoyed remarkable gains, but almost ludicrous gains. Those who invested in even smaller cryptocurrencies could have done even better.

As of this writing, there is already a small sign of a recovery in the cryptocurrency sector, but there is likely to be a medium term bear market in these assets because of all the above factors. Investors will seek to secure their gains, make their money “real,” and deal with an increased cost of living and an unstable political environment.

We’re also in unusual political times. The Biden Administration is suffering from historic unpopularity and barring a dramatic change, the Republican party is likely to win a tremendous victory in the mid-term elections. The party in opposition usually wins these elections, but this one may prove to be more devastating than most. To compare the mood within the two parties, less than 40% of Democrats want Joe Biden to run again. Meanwhile, former president Donald Trump, who even now is being accused of serious crimes by the majority party in Congress, commands 60% of GOP primary voters. In a head to head with Joe Biden, he would have a serious chance, and at this point, would be considered the favorite. That means that political gridlock and an even more heightened political temperature is likely.

Journalists may wave the bloody flag of January 6, but I don’t think many Americans care. They are more concerned about rising prices at the grocery store, rising crime, and a feeling of general malaise. We’re back in the 1970s in terms of national mood. Donald Trump’s rude tweets seem positively benign compared to a declining cost of purchasing power.

It is a long way from the Democrats’ hope of shepherding in a new economy based on climate change policies, infrastructure spending, and clean energy. Instead, Democrats are internally divided, desperate for revenue, and eager to crack down on investors whom they see as having profited during the pandemic. My objective political judgment is that they should have gone hard from the get go. Instead, they’ve disappointed progressives and lost rural America.

Meanwhile, Republicans benefit the most from this situation by doing nothing. In other words, we are not likely to get the regularity clarity that could potentially calm the cryptocurrency markets. Whatever the Biden Administration comes up with may simply be reversed by the next incoming Congress.

What should ordinary cryptocurrency investors do? There are three simple rules that may serve you well if you don’t want to be tearing your hair out every time you look at the exchange.

Get Your Political And Financial Executive Briefing… Every Morning Of Every Trading Day

First, as I’ve said to Rogue Investing Daily subscribers, practice “spare change” investing with the big two crypto assets, bitcoin and ether. Find a set amount you put away. Deposit it automatically. Ignore the news.

Bitcoin is digital gold, a store of value, and legal tender in at least one country. It is unlikely to lose its special status. Ether is likely to benefit from Ethereum 2.0, a series of reforms that will make the Ethereum blockchain far more scalable and easy to use. It’s coming in 2022 and promises to change just about everything about the sector.

DeFi, despite its complexity, is still based mostly on Ethereum. Simply invest in the big two two. Again, ignore the news barring an absolutely catastrophic decline. Think about what will happen over the next five years.

Second, if you can spare it, try to free up $100 for DeFi – but not in terms of an investment. Instead, learn to use some of the platforms and get a feel for what this emerging ecosystem is capable of. Most investors who are watching in horror as their assets decline probably have no idea what these tokens really do or why they are needed. The possibilities are exciting… but still in their infancy. It is worth learning this as a skill, but you may simply learn that this is not for you. You’ll simply be better able to decode the messianic promises made about the next new cryptocurrency. That will save you money otherwise wasted on a glorified Ponzi scheme.

To be clear, I don’t think many of the leading alt-coins – Chainlink, Cardano, Solana, Polkadot, etc – are schemes. They are tremendously exciting. It’s just the real growth and the ease of “on-ramps” for casual users are still taking place. Entering this market as a novice is foolish. Sacrifice a little money (which you may make back anway) as a kind of “tuition” for learning how this all works.

Finally, keep your eyes on political developments. While the stablecoin situation is troubling, there are alternatives that have already been created. Visa [V] is making big moves in this sector, are blockchain developers who are using algorithms and cryptocurrencies to back stablecoins, rather than direct holdings of fiat.

This stage for the cryptocurrency sector may ultimately strengthen it. Remember – Ethereum itself had to undergo a “hard fork” – essentially the creation of an entirely new blockchain – early in its history because of an exploit. It was tremendously controversial at the time and arguably violated the funding principles of blockchain. Yet it strengthened the platform over the long run.

What these smaller cryptocurrencies and exchanges are going through now may do the same thing. These tokens, systems, and blockchains are not simply generated by machines. They are generated by extremely dedicated and intelligent teams who see opportunities that others don’t. Not all of them will succeed. You are under no obligation to support their projects, especially because some of them serve niche markets. However, you can follow the general emerging regulatory climate, which is likely what is gong to restart the cryptocurrency bull market when the time is right.

This is not the death of blockchain nor of cryptocurrency. It is simply going to be a winnowing effect. The growth of decentralized finance, measured by the amount of money “locked in” to the system, has grown by ten times over the last year. It is understandable that there will be major failures, problems, and adjustments as people struggle to use this new tool.

Some of the projects may seem stupid. It could seem like something like Beanie Babies, or a speculative boom in essentially worthless assets. What people forget is that online crazes like that helped build the growth of revolutionary platforms like Ebay and Paypal. We don’t know where this is going. We are simply getting the first glimpse of what is possible.

What many are forgetting is that access to finance, new online projects, and the gains in efficiency are the purpose of this sector. It is not simply to pick tokens and hope for the best. Stack the big two, familiarize yourself with smaller coins and become comfortable with the exchange that meets your goals, and keep your eyes on Washington.

And make no mistake, my sources tell me that a “crypto lobby” is forming in Washington, and it has no intention of letting Big Government regulate the sector out of existence. Crypto isn’t going anywhere.

I would say buy the dip but I’m not confident the “dip” has fully arrived. However, given that my input into crypto each week is automatic, I don’t care. Given my returns over the last years, the strategy is working so far. The air has been let out of the balloon, but it will be refilled.

Mr. X is an investment analyst working in the Washington DC area who specializes in the intersection of business and public policy. After fifteen years working in politics, he writes on a classified basis for RogueInvesting.com to bring you news on what those with power are debating, planning, and doing.

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