Cryptocurrency meltdown topples digital asset businesses
San José, CA – With Bitcoin now down 70% from its record price in April of 2021, businesses based on cryptocurrencies have started to fold. The latest victim was Celsius, a crypto “bank” which stopped withdrawals from its accounts on Sunday, June 12. Celsius had more than $20 billion in assets at its peak in August 2021, drawing investors with yields of more than 18%. But Celsius is looking more and more like a high-tech Ponzi scheme that only lasted as long as new investors kept buying in.
The collapse of Celsius followed the collapse of the “stablecoin” Terra just last month. “Stablecoins” are digital currencies that are supposed to maintain a value of $1, unlike Bitcoin and other cryptocurrencies whose value can go up and down. But Terra was not backed by assets such as cash or Treasury Bills (short-term U.S. government bonds), instead it was “backed” by another cryptocurrency, Luna. The attraction of Terra was that it enabled investors to put their Terra coins into Anchor Protocol, which was paying interest rates similar to Celsius. But on May 7, Terra slipped below $1, and continued to drop, eventually losing more than 95% of its value.
The losses from Celsius and Terra are in the tens of billions of dollars, but pale compared to the losses by investors in Bitcoin and other cryptocurrencies. Bitcoin is based on solving complex mathematical problems, so it has the scarcity needed for money. The problem is that fundamentally it has little use aside criminal transactions, and even here governments are getting better at tracing and clawing back illegal crypto payments.
For decades low interest rates and low inflation have set the conditions for investors to pursue risky assets. First there was the boom and bust in dot-com stocks in companies that didn’t even have any revenue, not to mention profits. This was followed by bonds backed by risky mortgages which went into default with the bust in the housing market. Most recently there are Bitcoin and other cryptocurrencies, and a number of “DeFi” (decentralized finance) like Terra and Celsius.
But what is different today is that the economic environment has changed. Inflation, running at 9.3% (CPI-W) is the highest in 40 years. The Federal Reserve is raising interest rates to jack up the unemployment rate and bring down inflation. On June 15, the Federal Reserve raised short-term interest rates by three-quarters of one percent (0.75%), the biggest jump since 1994. On the same day, the Federal Reserve also began to reduce their $9 trillion stash of bonds by $47.5 billion a month, which will double to $95 billion a month in September. This will increase the amount of bonds on the market, pushing bond prices down and longer-term interest rates up.
This “double-barreled” increase in both short- and long-term interest rates has never been done in such an aggressive manner by the Fed. These interest rate increases are likely to begin to bring down inflation but are all but certain to bring about another recession.