On Crypto Crashes and Fake Money

When the cryptocurrency ecosystem sheds $2 trillion, we should pause to notice where it went.

This is going to be a short one, I swear.

Cryptocurrencies are crashing right now. You love to see it. A few months ago, the price of bitcoin was close to $125,000. Last night it hit a low of $60,000. It has bounced back to around $70,000 now. The chart below is just the past month. It’s probably too early to declare another “crypto winter” (don’t jinx this, folks!), but it’s clearly more than just a blip.

Paul Kedrosky flagged yesterday afternoon that the broader crypto ecosystem has shed $2 trillion.

That’s enough nominal value for things to get interesting (derogatory). Ponzi schemes and other assorted scams tend to do fine when times are flush. It’s only when people start calling in loans that they get exposed, producing a contagion effect on other shady counterparties.

But it also raises a specific, very basic point: when we say $2 trillion was lost from the crypto ecosystem, we should also be clear about where it went. It went nowhere. That money was never real to begin with.

Consider this toy example: you create a new cryptocurrency. Call it Futurecoin. You mint 1,000,000,001 futurecoin tokens. You sell one futurecoin token to a friend for one dollar. Maybe they buy it because they’re in on the grift, or maybe they buy it because you sold them on a dazzling vision where futurecoin replaces the dollar, or maybe they buy it because they think its’s funny.

The market has now priced futurecoin at a dollar, so the market cap of Futurecoin is nominally over $1 billion. That’s obviously hollow, since if you tried to find buyers for the other billion tokens, the price would collapse to zero. But market cap is just PRICE x SHARES.

Now imagine that you went to a bank and said “hey, can I have a $50 million loan? I’m good for it. I have $1 billion in futurecoin that I can offer as collateral.” Hopefully the banker would say "hey that’s very funny. I am grinning while I kick you out of this establishment.” But it’s also entirely possible that some banker would say “let me run some risk calculations on the likelihood futurecoin’s collapse, so I can appropriately price the thing. Ooh, you’re saying this coin is the future? I like these odds. Sure, here’s your loan.” Now your fake currency is hooked into the real financial system. And that’s, y’know, bad.

We have rules against this sort of thing. But we don’t really enforce them much anymore, because (to oversimplify it just a bit) the various futurecoin companies spent over a quarter of a billion dollars to influence the 2024 election, and they have hired very expensive lawyers too, so now we have a legislative branch that wants to make nice with them and an executive branch that has basically bought into the grift.

If you read Molly White or Matt Levine then you know all of this already. It’s pretty foundational stuff. But I think it bears repeating at a moment like this.

Cryptocurrencies haven’t lost $2 trillion in actual dollars. Actual money wasn’t taken out of crypto and spent on something else. What happened is that the marginal price of various cryptocurrencies has gone down. When the going rate for Bitcoin was $120,000, all the bitcoin holders could pretend they had $120,000. And they could use that bitcoin as collateral without bothering to sell it. Which was important, because if they all sold it, the price would collapse and they would find out that it wasn’t actually worth nearly that much.

When the price of Bitcoin drops to $60,000, the market cap is cut in half. But even that is fake, because Bitcoin is a speculative asset with no fundamental value. It is only ever worth what the next person is willing to buy it for (or whatever discount banks apply to it as collateral).

My hunch is that the current crypto crash is tied to the AI bubble. The price of bitcoin and other cryptocurrencies has been backstopped by a lot of very rich tech and finance people, who keep the whole system afloat by providing liquidity when it falls below a predetermined threshold. Many of those people have now diverted their investments toward AI companies and their associated phenomenal capital expenditures. So there may simply be fewer buyers-of-last-resort available to keep things from spiraling out of control.

Again, I’m not ready to declare a crypto winter just yet. The price of Bitcoin will go back up so long as someone with a lot of resources decides it is worth spending to reinflate the thing. But this is, at the very least, a phenomenon worth watching. When crypto prices fell in 2022, a few big scams were exposed, and that led to pretty massive contagion because everything was collateral for everything else. If prices stay low for a few more weeks, the cracks in the system might become impossible to ignore. And that’s when things get very interesting indeed.