Return of the Great American Bubble Machine

On May 12, 2022, just over fourteen years after the collapse of Bear Stearns, the New York Times announced another crash. In a story entitled, “Cryptocurrencies Melt Down in a ‘Perfect Storm’ of Fear and Panic,” the lede read:

A steep sell-off that gained momentum this week starkly illustrated the risks of the experimental and unregulated digital currencies.

The story told of a mass investor flight from cryptocurrency markets, which has since caused an astonishing $700 billion in losses. There were several key triggering events, including the collapse of a “stablecoin” product called TerraUSD. A stablecoin is a type of digital currency that’s usually pegged to the value of a “stable” reserve asset like a dollar. They are often used to enter and exit trades for other cryptocurrencies, like Bitcoin.

In theory, stablecoins work, if they’re backed by real assets and by guarantees that hog-tie the customer to their money in adverse conditions. Part of the idea behind a stablecoin is to be the calmer end of the volatile crypto experience. As Bloomberg put it, stablecoins can be a “safe haven” for investors, who can keep their holdings “protected from wild swings in the crypto market” without need to “convert their holdings into traditional money.” But the implosion of TerraUSD put a big early dent in the “safe haven” description.

That wasn’t the only factor. Just days after TerraUSD lost its “peg” and started its freefall in early May, financial observers found an eyebrow-raising passage in the already-disappointing quarterly 10-K report of a crypto market leader, Coinbase. In addition to reporting a $430 million loss and a 19% drop in users, the company stated:

In the event of a bankruptcy, the crypto assets we hold in custody on behalf of our customers could be subject to bankruptcy proceedings and such customers could be treated as our general unsecured creditors.

Coinbase is the largest cryptocurrency trading platform in the United States. When a customer stores cryptocurrency in a Coinbase wallet, those funds in theory can only be accessed with a cryptography-protected key, making it, again in theory, the unique property of the customer.

This type of protection is supposedly what’s at the heart of the crypto revolution, powered by its underlying Blockchain technology. The new method for storing data creates unique, timestamped “chains” of information visible to everyone in a digital community. In a theoretical Blockchain world all financial history would be visible, instantly recallable, and set in stone, making customers immune to the kind of non-transparent, triple-dealing corruption that ruined those who placed their trust in infamous black boxes like Lehman Brothers prior to 2008.

The Coinbase disclosure however brought back some of these memories. In the event of a bankruptcy, the firm’s 10-K release said, risk existed that people with funds in Coinbase wallets could find themselves fighting with other Coinbase creditors in a legal proceeding to decide who was owed first. No matter how sound a company it was or is, Coinbase posed the same theoretical problems that all financial institutions posed to customers in the pre-crypto world, forcing users to put trust in those opaque institutions known as “centralized” ledgers.

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