By now everyone knows Bitcoin, the reference among crypto coins. This coin rose from 2,000 euros at the beginning of September 2021 to 56,000 euros in one year. But the fall came just as quickly. Now we are at 16,300 euros, which is still a nice increase compared to two years ago.
Other cryptocurrencies fared much worse. Before going into more detail, a word of explanation about this complex matter, where apparently everything is intertwined.
What is Cryptocurrency?
There are approximately 21,800 crypto coins in circulation, but only 9,300 are in active use. The most important crypto coins are Bitcoin (BTC), Ethereum (ETC) and Tether (USDT). The latter is linked to the exchange rate of the US dollar. USD 55 billion is traded daily. There are about 300 million users in the world (half of them in Asia), and 18,000 companies use it as a means of payment.
Bitcoin was created as a general-purpose currency to replace or enhance government-issued traditional currencies (“fiat money”). However, the crypto coin is also used for transactions that shy away from the light of day. If you have bought crypto coins, you can store them in a digital wallet: the ‘wallet’. You can also save them on your laptop, phone or keep them online. You can also print the Bitcoin old-fashioned on paper, but that is practically not done.
Cryptocurrencies are created by blockchain, which is a digital registry of stored data. In this case it is the genesis for each unit of the cryptocurrency that shows which owners the cryptos have had over time. Blockchain works by storing transactions in ‘blocks’, with new blocks being stored at the beginning of the ‘chain’. It has unique security features, which a normal computer file does not have. For example, the blockchain file is stored on different computers in a network and can normally be viewed by everyone within that network. This makes it transparent and difficult to change.
These blocks are then linked together using complex computational cryptography and computer science. Any attempt to change the data disrupts the cryptographic links between the blocks and can quickly be labeled fraudulent by the computers on the network. Cryptocurrency mining is the process of checking recent cryptocurrency transactions and adding new blocks to the blockchain based on a complex algorithm. So it leads to new crypto coins. However, this is a very energy-consuming process by means of computers, which was widely used in India and China. Since it is therefore polluting, it was strongly restricted in China. Mining is not possible forever. Only a maximum of 21 million of Bitcoin can be created.
Investing always involves risks, but that is even more true with cryptocurrency.
– The cryptocurrency has no fixed value and there are many price fluctuations. Unlike a currency, the price of the cryptocurrency does not reflect the macroeconomic condition of a country and there is no central bank that can support its price. In principle, no interest rates are linked to cryptocurrency. Nor does it conform to the basic principles of money (medium of exchange, store of value and medium of account). It is therefore regarded by many as a ‘good’ or ‘commodity’.
– The crypto coin therefore has no underlying value: the price depends entirely on supply and demand. This of course applies to more forms of investment, such as shares and bonds. Yet there is an important difference. With a share you own a small part of a company. With a bond you lend money to a company or government. There is ‘nothing’ behind a Bitcoin. That is why people prefer to speak entirely of ‘speculating’ rather than ‘investing’.
– The cryptocurrency does not generate cash flow like real estate or dividends. It also cannot be used in production like raw materials, nor does it provide social benefits like gold. The crypto currency is therefore in fact irrelevant and the European Central Bank (ECB) therefore expects it to come to an end.
– There are digital bank robbers, or ‘hackers’ who try to rob your digital wallet. Sometimes a market party for Bitcoins suddenly disappears and you have lost all your cryptocurrency.
– Cryptocurrency is a complicated product. It is important that you know how it works and how crypto coins are ‘made’. If you don’t understand it, don’t invest in it.
– There is insufficient or no supervision by the government. In Belgium this is the FSMA, or the Financial Services and Markets Authority.
– Linked to this, there is also no legal protection. There is a deposit guarantee scheme up to 100,000 for savings at the bank, but there is no safety net for crypto money.
So much money
So why is it that the crypto markets are attracting so much money? This is due to the spectacular price increases until a year ago and the fact that the digital currency comes across as ‘sexy’. Last year, El Salvador became the first country in the world to make Bitcoin legal tender. It was a total failure and cost the poor country and its people a lot of money. However, the fairy tale came to an end. First and foremost due to the sharp rise in interest rates, but mainly due to some downsizing in the market, until the recent fiasco of the FTX trading platform in November.
Just like on the stock exchanges, you can trade derivatives or derivative products on the crypto markets: the CFDs (Contract For Difference). It allows you to speculate on an underlying cryptocurrency without having to own it. CFDs work with a leverage effect: you only have to put in a small amount to take a large position in a cryptocurrency, which can greatly increase both your profit and your loss, depending on the underlying price movement.
What is a crypto market?
Crypto exchanges are the stock exchanges of the digital world. And just as you can buy, sell and trade hundreds or thousands of shares on the stock exchanges, you can buy, sell and trade hundreds or thousands of digital currencies online (via an app) on crypto exchanges. Collectively, those currencies make up the crypto market. They work like online brokers: users can deposit traditional “fiat money” with this marketplace, and then use it to purchase cryptocurrencies. This can happen with orders placed in the market by the market makers. A ‘market maker’ ensures that a supply arises for every demand, or vice versa.
There are more than three hundred crypto exchanges that specialize only in the trading of crypto currencies. They can be decentralized, where the users themselves keep track of the crypto coins with their ‘keys/token’ in their ‘wallet’, or centralized where the platform keeps track of the keys (token) of the purchased crypto coins for someone. The latter is of course more risky because you have a counterparty risk on the exchange in question that holds these keys. But the global crypto exchanges must in principle comply with financial regulations.
The best crypto exchanges have the following ranking: Pionex, Bitstamp, NAGA, CoinSmart, Crypto.com (sponsor of the football World Cup in Qatar), Binance, … The latter was only founded in 2017 by the Chinese Changpeng Zhao and launched its own crypto coin Binance Coin (BNB). Zhao played a major role in the recent defeat of the FTX exchange. Cash App is in twelfth place, with Jack Dorsey as CEO. He is the co-founder of the social medium Twitter, and also served as its CEO until Elon Musk recently acquired it for $44 billion.
The fairy tale of crypto coins took a serious blow this year, and people are now even talking about a ‘crypto winter.’ The first trigger was the rise in interest rates that burst the bubble: the discounted yield of such risky investments plummeted, leading to profit-taking, and then a downward spiral.
The first victims were the algorithmic stablecoin TerraUSD (UST) and its sister coin that supported it, namely Terra (LUNA). A stable coin promises stability, while LUNA was a normal volatile crypto coin. In May, LUNA was worth $116, while now 100 LUNA is worth just $0.002. Investors lost $40 billion and negative dominoes sprang up throughout the crypto industry.
On November 11, the crypto exchange FTX sought protection from creditors, and it is likely to go bankrupt. This trading platform, founded by the now barely 30-year-old Sam Bankman-Fried, had grown in three years to become one of the largest crypto exchanges in the world, on which four billion dollars in virtual coins were traded until recently. Bankman-Fried had accumulated a personal wealth of $26.5 billion, which has now completely evaporated. FTX was thus a sponsor of Mercedes in formula one. The platform also had many Belgian customers.
The cause is the fact that FTX lent billions of dollars in customer assets to sister company Almeda, which used it as a hedge fund to make risky investments that went wrong. Few were aware of this. In regular stock trading, such a construction is unthinkable, as there is always a strict separation between the broker and the client assets. It turned out afterwards that FTX, as a hyped crypto exchange, had little real underlying value, but it did have a gigantic mountain of debt of more than ten billion dollars.
Binance hastened FTX’s demise by announcing on Twitter that it would be dumping the digital tokens around the FTX platform, after seemingly offering a bailout first. Resulting in total panic. After the implosion of FTX, $200 billion worth of crypto value went up in smoke. Here, too, a domino effect is now occurring in the negative sense. Another crypto company, BlockFi, filed for creditor protection: it is facing difficulties because it had outstanding loans with its FTX sister company Alameda. Yet another crypto platform, Genesis, says it needs $1 billion in fresh capital. It had $175 million outstanding in an account with FTX, which has now been blocked. In turn, Genesis’ clients seek to liquidate their outstanding investments with this broker. That for an amount that exceeds the value of the capital at Genesis. Who’s next?