There have been plenty of “I told you so’s” floating around the finance industry as the global cryptocurrency market has hit the rocks this year. After more than half a decade of staggering growth in value – of a magnitude that at times threatened to rewrite the rules of finance as we know them – wise old observers have been quick to pile in with their assessment that it just had to happen eventually.
Even for an asset class as disruptive and as volatile as crypto, its decline has been as spectacular as its stellar ascent. Worldwide, crypto markets have lost some $2 trillion in value in less than 12 months. There have been stampedes to withdraw investments in crypto assets which are tantamount to a run on a bank.
Widespread consensus will tell you that the meteoric rise of crypto was simply unsustainable. The bubble had to burst. But there are mitigating circumstances. Worldwide, the economic outlook is pretty bleak. Inflation is soaring, interest rates are rising, recession is looming. Investors have less to invest and confidence (and value) in most markets is on the decline.
In a market as fast-paced and supercharged as crypto, everything is magnified – highs and lows. It may not be that there is anything intrinsic to crypto itself, or that it grew too fast and simply had to crash and burn. It may simply be that crypto’s current woes hold a mirror up to the economic turmoil we’re seeing everywhere.
Forgetting the basics of risk management
There is also an argument that the phenomenal success of cryptocurrencies has led to a gung-ho attitude that has become increasingly blind to risk. It’s a stance recently adopted by Coinbase, the US’s largest cryptocurrency exchange, which has seen 81% wiped off its stock value this year, and reported first quarter losses of £430 million.
However, Coinbase remains in operation and, according to its senior figures, solvent – unlike a lot of other exchanges and crypto investment companies that have either fallen by the wayside or are staring into the abyss.
A recent blog post signed off by three senior Coinbase executives pulls no punches. Crypto businesses facing insolvency in the current crisis – and investors who were facing ruin to boot – can not point the finger of blame at cryptocurrency itself for their woes. Their problems are, they argue, “credit specific, not crypto specific”.
It’s interesting to read some of the reasons given by the Coinbase execs to explain why so many outfits in their industry are now facing oblivion. The talk about firms being “overleveraged with short term liabilities”, taking “unhedged bets” and having “insufficient risk controls” in place. Most starkly, they accuse players in the crypto industry of forgetting “the basics of risk management.”
There are some universal truths here about credit control that apply to any industry, to any business. They could just as well be talking about firms overloading themselves with readily available cheap credit at times when interest rates are low and the economic outlook is rosy (remember the Credit Crunch of the late noughties).
The danger when times are good in buoyant markets is you start to believe things will be like that forever. You take more risks with your finances, you start thinking purely in terms of short term gains rather than long term stability.
It’s when the economic wheels turn, as they have done now, that those who have left themselves overexposed and overleveraged find they are out of their depth.
The current economic climate means that taking financial risks is hardly on the cards for any business. Prudence, caution and survival are the aims of the game right now. But if there’s a lesson to be learned from the current woes faced by the crypto market, these are values well worth remembering even at times when your business feels invincible.
