Wikipedia defines a Ponzi as a form of fraud that lures investors and pays profits to earlier investors with funds from more recent investors. The greater fool theory revolves around the pushing of an asset price higher by attracting more people and creating a FOMO (Fear Of Missing Out) environment.
The above 2 points perfectly describe the crypto markets today. BUT they can also be used to explain any other asset classes too. SPACs and NFTs are one. So are FANG stocks, plus traditional investments like stocks and bonds.
The premise of investment is to buy a promising asset ahead of anyone else before the man in the street discovers the hidden value. One then sells out when the hype stops justifying the valuation. Easy said than done.
We are now seeing a crypto winter, no thanks to the meltdown of all asset classes since the start of the year. There are many reasons being debated to justify the drop. It was the Ukraine war by Russia. Oil prices hitting $120. The ending of Covid as we return to a sense of normalcy. Supply chains getting stuck again after 2 years of standstill. Too many years of money printing by Central Banks that inflated all asset classes and now it comes back to bite us in the ass.
In hindsight, we should have seen it coming. Again, easier said than done. This was after so many years of binge drinking the Koolaid of successfully buying the dips. As more new money had been poured into the flaming fire of asset pumping, the rally was being fueled and turbocharged by new central banks accounting tricks.
More than 30% of US dollars were created over the last 18 months alone. The Fed had tried to overcome Covid by throwing UBI (Universal Basic Income) at its citizens in an effort to save the economy. And most other countries followed the same playbook as the pandemic froze all economies in their track. This adrenaline rush stop-gap measure always works from the 2008 GFC until the day it breaks the system. Is the day of reckoning at hand? Is the moment of truth here now? Will it work again? It looks inevitable that central banks may have to print more and pump the accelerator again within the next 6 to 12 months again.
Within the crypto space, we had seen a +10x rally beginning from Jan 2021 as the Gamestop saga successfully pitched the everyday man against the professional money managers. It emboldened individuals to hop onto the “sure-win” bandwagon of overnight riches with tips from newly created Clubhouse “professionals”. Many were touting new meme coins plus Bored Apes wannabes NFTs.
The crypto markets surged to a $3 trillion value and newly created billionaires fought against the old financial world. They pushed Defi (Decentralized Finance) aggressively by creating even fancier shinier objects to ramp up. The blurring of investment to speculation to Ponzi was mind-blowing. Cryptos are now below $1 trillion as 2/3 of the value had been destroyed.
And the party crashed spectacularly this week to new lows. The domino effect is shaking the crypto space to its core as the top 2 cryptos BTC and ETH got savaged. The fast and furious world of this market showed that volatility can increase on the downside as well as the upside. The destruction of the Terra Luna stablecoin, which suddenly became not so stable after all, is a painful lesson to learn.
Can we really create something out of nothing? Yes, we can and have been doing it for years. Take, for example, online gaming. As one gets more involved in the game, one can exchange fiat currency for online money to purchase and enhance your gaming experience. The company creates online gaming gold tokens out of thin air in order to collect your dollars.
Look at the recent collapse of the Terra Luna algorithmic stablecoin to maintain its peg. The foundation promised a yield of up to 20% per annum for staking via Anchor, the lending and borrowing protocol . How does it pay for the promised yield? By creating more tokens, duh!. If you believe that the price will be stable or heading higher, then FOMO will prevent you from cashing out.
The rug pull happens when everyone suddenly wants to exit at the same time. The logical algo-driven process is theoretically sound on paper but when a black swan event hits, no one knows if it can survive the onslaught. The real world has a bad habit of catching you with your pants down when you least expect it. It took only 2 withdrawal trades of about $100 million each to cause the depeg and the tokens spiral to almost zero within hours.
Suddenly, we are now seeing many asset price drops of 75 to 99% as being the norm, rather than the exception. It becomes crazy and we get numb to it like a rabbit on a highway watching the headlights of an approaching truck till impact. There is no time to react. Or is there?
There were signs out there for months but we refuse to believe that this time it is different. Many previous times of successfully buying the dips had conditioned us to do the same thing again and again, to double down. This time, our cash reserves are diminishing until we can do it no more.
The Terra Luna collapse has begun to threatened a contingent domino effect which had affected other algo stablecoins. Some exchanges like Celsius had started to freeze withdrawals and fueled more panic. Just this week, BTC had dropped almost 30% from 30 to 20k while ETH had also had a similar move from 2 to 1.1k. The total meltdown is a capitulation of highly leveraged positions seeking the exit door. The market smells blood and weak positions are being flushed out on the downside.
By the way, is Covid over yet? My blog weekly count since the start of the pandemic is 120 this week. I believe that we have already moved to an endemic stage. Historically, a virus tries its best to survive by being more contagious. But it also gets less deadly to ensure that the human hosts can allow it to continue to spread. That being the case, I will stop the weekly count today.
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