It’s hard to believe that the financial crisis of 2008 unfolded nearly 15 years ago. It’s possible that those who are heavily involved in the cryptocurrency industry today are too young to remember the devastating impact that 2008 crash had on all sectors, from real estate to small businesses, and especially banking. Cryptocurrency investors now stand at the precipice of another meltdown that draws some notable parallels to what we experienced in 2008.
In a late June 2022 article, Bloomberg noted that “a web of interconnectedness” has exposed a “tangle of derivatives” that harkens back to what took the financial system down in 2008. Bitcoin has plummeted nearly 70% from its record highs, and the simultaneous crash of the Terra ecosystem — an experimental, decentralized blockchain system — resulted in a combined total of $60 billion in crypto coins becoming virtually worthless.
With volatility high, financial experts are quick to draw comparisons to 2008 and see if we can ferret out some lessons from that most recent economic downturn.
From 2008 to 2022
“In 2008, the collateralized debt obligations (CDO) market rehypothecated risk and mortgage delinquency exposure to such an extent that esoteric derivative instruments knew which counterparties held risk on their books,” explains Shane Molidor, CEO of AscendEX, a cryptocurrency trading platform. CDOs that invested in subprime mortgage securities were at the heart of the 2008 financial crisis. Even though the issuing of subprime CDOs halted after the crash of 2008, this did not mean that other risky financial investments and loans ended.
On the contrary, the leveraged loan market has only grown in popularity.
Cryptocurrency then entered the lending game, with many coins straddling the line between centralized and decentralized finance. Many crypto lenders were lending customer deposits out through crypto hedge fund Three Arrows Capital (3AC) in return for high yields, but little attention was paid to how 3AC deployed the borrowed capital.
As many know, 3AC was ordered to liquidate on June 27, 2022 after failing to meet its margin call and subsequently failing to repay the money lent from crypto broker Voyager Digital. As of July 11, 2022, the founders of 3AC are missing.
The problems from 2008 came rushing back to bite crypto investors in the worst way possible: substitute dollars backed by nothing have led to a crash of epic proportions.
“Just as many CDO investors were unaware of their exposure to subprime mortgage delinquencies, many retail customers who deposited funds into major crypto lenders never understood where the yield came from,” explains Molidor.
Lessons Not Learned
The rise of cryptocurrency was bolstered by the excitement of a new financial frontier. Supported by the feeling of financial liberty and an escape from a centralized financial system that had just crashed spectacularly, early crypto adopters believed they had found a better way.
Much like the lead-up to the 2008 crash, the crypto market has ballooned exponentially throughout the past several years. The stark difference between 2008 and today, however, is that real estate assets backed the dollar-equivalent products from 2008. This all worked wonderfully until the real estate market took a nosedive. The cryptocurrency market, on the other hand, is not supported by any assets as relatively sturdy as real estate. Cryptocurrency traders work in US dollars, and the market has always been volatile.
“We also find it notable, yet altogether unsurprising, that many of the worst excesses in crypto have come at the nexus of CeFi and DeFi,” says Molidor. Crypto “stablecoins” created and supposedly backed by one US dollar each were not fully backed, and the stablecoins that were reserve-backed were never fully audited. Issuers could simply show a snapshot of their coin’s backing, borrow money to claim backing, and return it immediately after the snapshot was presented. This climate of bait-and-switch, trickery, and outright fraud combined to create a perfect storm leading to eventual collapse, just as it did for the centralized financial market in 2008.
The culprit of both crashes seems to be an over-leveraged dollar-equivalent product. Leaders in the cryptocurrency sector may have believed they were the outlaws of the financial world, creating a new way to invest and grow wealth. Instead, they ended up repeating the same mistakes made by those 15 years before.
The Way Forward
For everything different about cryptocurrency, the industry behaves much like other financial sectors, with buzzwords like “boom,” “bust,” “bubble,” and “hype” flying wildly through headlines striving to predict what will happen next. Experts hypothesize that there needs to be some regulation to move forward with cryptocurrency as a viable means of investing, saving, or spending.
Thomas Edison once said, “The value of an idea lies in the using of it.” Cryptocurrency has been hailed as the next great financial innovation, touted as a game-changer, and made many people rich. However, those who have used it for nefarious purposes — and in an attempt to line their pockets at the expense of regular investors — are effectively diminishing the overall value of the idea.
As crypto investors keep an eagle eye on the markets to try and anticipate what is to come, experts continue to search for a way back. Much like 2008, it may take the desolation of the market and a complete rebuild, with some significant changes, for crypto to claw its way out of this most recent crash.