If you invested £100 ($122) in the Luna cryptocurrency a month ago, you can be confidently confident that you made a sensible bet. But Luna’s value has since dropped dramatically – at the time of writing, that £100 is worth around 4p (5¢).
Luna was by no means the only victim in a week where cryptocurrencies dropped 30%. Some have recovered to some extent, but this still represents a seven-day aggregate loss of more than $500 million (£410 million), raising existential questions about the future of the market.
This crash was possibly triggered by a financial “attack” on stablecoin Terra (UST), which was supposed to be the US dollar but is currently trading at just 18 cents. Its partner currency Luna subsequently collapsed.
THE attack This type is extremely complex and involves placing various trades on the cryptocurrency market in an attempt to trigger certain effects – which can provide the “attacker” with significant gains.
In this case, those exchanges caused Earth to fall, which in turn also knocked its partner currency Luna down. Once this was noticed, it caused panic, which in turn triggered market pullbacks, which caused even more panic. Some (but not all) stablecoins are largely dependent on perception and trust – and once that is shaken, big dips can take effect.
Crucially, the recent big drops in cryptocurrencies have called into question just how stable stablecoins really are. After all, they are designed to have virtually zero volatility, keeping a “peg” to some other underlying asset.
However, the effects seen this week have spread across the crypto space, to create single-day losses similar to – or possibly worse than – a “Black Wednesday” for crypto (Black Wednesday was the day when 1992 when speculators forced a collapse in the cryptocurrency market). pound value). Even the leading stablecoin Tether has lost its peg, dropping to 95 cents on the dollar, perhaps demonstrating the need for regulation. For if stablecoins are not stable, then where is the safe space for cryptocurrencies?
How investors respond will be critical to the future of cryptocurrencies. We’ve already seen panic and despair, with some comparing this crash to a traditional bank run. But with bank runs, customers tend to worry that the bank won’t be able to give them their money, rather than that their money has become useless.
A more accurate comparison is with stock market crashes where investors worry that the stocks they hold could soon lose value. And so far, the reaction to this cryptocurrency crash suggests that a large portion of cryptocurrency holders view their investments in a similar way.
Despite historical price volatility, there is a basic assumption often seen in investor behavior: that the asset price will rise and continue to rise. In this scenario, the investor does not want to be left out. They see the asset going up, consider it a “sure thing” and then invest.
Often spurred on by early successes, the investor can then invest more. Combine that with social media and the fear of missing out on “unavoidable” gains, and the investments continue.
Simply put, many invested in cryptocurrencies because they believed it would make them richer. This belief was undoubtedly shaken.
But another motivation for investing in cryptocurrencies could be a belief in their transformational nature, the idea that cryptocurrencies will eventually replace traditional forms of financial exchange.
For these investors, any increase in the value of a cryptocurrency is a demonstration of the cryptocurrency’s growing power over traditional money. But by the same token, a significant decline in the value of cryptocurrency is not simply a monetary loss – it is an ideological loss.
At the same time, however, this ideological stance creates a group of investors far less likely to sell in the face of any sharp downturn. And it is this group that can still give hope to the sector.
In established stock market crashes, we speak of a return to “fundamental value”. The fundamental value of encryption is often assumed to be zero. However, perhaps there is at least some core value based on belief. The size of the pool of investors who own cryptocurrency because they believe in its long-term future and the promise of new money can determine this cryptocurrency’s fundamental value.
In fact, if we consider cryptocurrency investors as different groups with different motivations, we can better understand the behaviors we are seeing. Investors can perhaps take comfort in the fact that we may have seen the worst of this crisis and that better times may be ahead. But as any financial advisor will tell you, in cryptocurrencies as in any other market, nothing is guaranteed.
This article by Gavin Brown, Associate Professor in Financial Technology, University of Liverpool; Richard Whittle, CAPE Policy Fellow, UCL, and Stuart Mills, Fellow of Behavioral Science, London School of Economics and Political Science is republished from The Conversation under a Creative Commons license. Read the original article.