It looks like there’s no where to hide as virtually all financial assets are taking it on the chin. The news is everywhere and there’s no need to recap here, you know what’s going on. What is interesting to me from a high-level view is how the carnage in the markets may ultimately course-correct many things, in the market and society as a whole, and we can thank an unlikely and very unpopular phenomenon, inflation.
Before I get there, I need to briefly set the table on a few things with the wildness in the crypto market and where we are. We’re witnessing two major blow ups, one with a centralized exchange, Celsius, and the second an over-levered VC, Three Arrows Capital (3ac). These together result in billions of dollars in liquidation losses due to gross risk mismanagement. It looks like both are suffering huge liquidations, which is adding to the carnage in the market.
I’m vaguely aware of the full extent of each, especially as the smoke settles on the blow-ups, but what I can say is that each company were taking excessive risks behind the scenes without the full knowledge of the customer/investor base, which has now unwound in billions in losses.
Events like these are primetime bear market activities, and occur in virtually all financial markets. The pressure and gravity of a downturn exposes and exploits vulnerabilities in a system, and those that didn’t appropriately manage potential risks are going under.
Another sign of the times is Schadenfreude makes an appearance. For those unfamiliar with the term, here’s a quick definition:
Schadenfreude
/ˈSHädənˌfroidə/
noun
pleasure derived by someone from another person's misfortune.
Although at times I’ve been guilty of it, in hindsight it’s ultimately unhelpful and resembles its close cousin, resentment. Schadenfreude makes a full appearance on the front page of the Wall Street Journal this Saturday, but more specifically within the comment section. Comment sections, although typically a complete mess, in some contexts provide a good sentiment check. The article “The Crypto Party is Over1” gave a good recap of 2022, but it was the resentment in the comment section that caught my attention. There is a bubbling hatred within the older investment cohort towards crypto, in which many may have been waiting for this moment to come bursting out, and bursting out it did:
Crypto is a reflection of this generation of 35 and under. A generation brought up by instant gratification and no work ethic. Our country has a labor market crisis as a result of the poor parenting of these brats. They are susceptible to get quick rich scams. Anything but roll out of bed early and roll up the sleeves and get a day’s work under your belt. Today’s men are full of soy and empty heads.
Crypto: fake money, real losses
Crypto is a trash investment. This whole speculative bubble was built on the "greater fool" theory, and eventually reality inevitably punches that kind of unbridled euphoria right back to earth. This might not be the last dance for Bitcoin and others, but eventually people will look back retrospectively and wonder why the investors of this era tossed their life savings away in the hope that the rising value of electronic Monopoly money would eventually enrich them. But, hey, to each their own... I've got to go plant these tulips, so we'll have to continue this conversation later.
These comments have been around for the better part of a decade, since Bitcoin came into public consciousness a few years after its invention in 2009. The hubris in most comments above aren’t lost on me. As others pointed out, the creation of Bitcoin came about due to the above commentors over-leveraging their homes and other assets, blowing up, and consequently taking the world economy along with them while most in the crypto space were graduating high school. Not to mention leaving a massive bill of Federal debt in the multi-trillions:
So easy on the “our generation” talk; the true genesis of crypto and Web 3 was to build an alternative to what we have, an attempt to course-correct where we are, and at the very least provide some hedges to the current system. And speaking of bailouts, in the cyrpto world, we’re on our own. That aspect I like because it allows the market to more efficiently and quickly find solutions. A bad project can only be propped up for so long.
At the risk of exercising schadenfreude myself, it’s worth pointing out that dancing on the graves of the crypto downturn may be an attempt to ease the pain of all markets going through a downturn. Everyone is taking a hit.
To wrap this point, I was too young to remember how conversations were surrounding the Dot-Com bust, but I strongly suspect that things rhymed with today’s technology downturn. I’m starting to think that the pattern of major technological progress looks the same each time. What came of the Dot-Com bust are now the largest companies in the world and a major component of our economy. I would bet that the same is occurring right now.
That said, I wanted to express gratitude for an unlikely and very unpopular phenomenon going on: Inflation. The natural question is why? Why in the world are you grateful for that?
In thinking through the very large problems in today’s world, specifically in financial terms, inflation now seems to be the only natural braking force to all government actors from printing and distributing money out of existence. It’s the free market reasserting itself from the hubris of central authorities. The answer for years when things got rocky, especially during the pandemic, was to hand out “free” money. All incentives were pointed in the same direction, similar to the GFC, in that the citizens scream for the politicians (the ones with access to the printing press) to do something, which they gladly will considering their own incentives are to stay in office. For a very long time inflation didn’t appear. I think most of this was due to the disinflationary effects of technology, but I know the issue is much more complicated than that.
So now with inflation roaring and recessionary signs bubbling, the typical solution to an economic downturn is one of the causes itself, monetary stimulus. In that aspect I’m grateful for inflation, because it reintroduced to everyone the risks, and Lord Almighty everyone hates inflation. Those same politicians are scrambling to find a way to deflect the blame and stay in office, but no one is safe. Along those lines, I think this upcoming election will produce some scar tissue that will be remembered each time the idea of sending out stimulus checks or running a massive deficit seems like a risk-free plan. Although I’m aware that inflation is much more complicated than that, you get where I’m going.
The other thing I’m grateful for is that inflation is a shared burden, everyone has to pay. It affects different people in different ways, like everything in life, but this is a shared pain whether at the gas pump or your 401k.
Shifting back to the economy, a good effect this inflationary period has produced is to add gravity back to a financial system that went too long without it. Like being in outer space for too long, there were numerous companies who’s bones were too weak to withstand a more normalized financial environment in which capital cost something. In both crypto and throughout the economy, we’re witnessing bones breaking, with the net result in a major drawdown and events like the ones described at the beginning of this piece.
The reality of “earning” APY on crypto had a major reality check over the past several weeks, and expectations are being quickly reset. What seemed to be easy money on one hand, ended up being subsidized yields to manufacture an attempt at a network effect, or worse unknown risk taking to produce the yields. They were customer acquisition costs run amok. Additionally, leverage throughout the crypto system was rampant, and this being unwound is a good, albeit painful, reaction.
The effect of all of it, is to ask yourself why we were here in the first place? Going back to the genesis principles of why crypto and Web 3 exist is the most productive effect of inflation to me. Inflation ended up being the acid test that crypto needed, because it’s in downturns that great things are born. Inflation and the knock on recessionary effects reorient everyone’s perception of what is important. And for that I’m grateful.
Will
https://www.wsj.com/articles/the-crypto-party-is-over-11655524807?mod=hp_lead_pos7