The financialization of crypto made it vulnerable to the kind of contagion we're now seeing.
The big change in crypto between 2018 and today is the introduction of large-scale lending to the sector. And with lending comes a new kind of risk — counterparty risk — that crypto still hasn't found a good way of dealing with.Crypto is notoriously cyclical — the price of bitcoin plunged 70% in 2011, 83% in 2013, and 84% in 2018. Those drawdowns were all relatively harmless, however, in comparison to the leverage-induced carnage being wrought during the current crypto winter.
Part of that is just because the amount of money at stake was much smaller back then. But another big part of it is that crypto wasn't really financialized then — there was almost zero lending, shorting, and the like.At the heart of the crypto project is a technological feat: The ability to create digital objects that exist only in one place and can't be copied. If I send you a bitcoin, I can't send that same bitcoin to someone else.
As a result, if I own a bitcoin, that bitcoin can go down in value, or even be stolen, but those losses are mine alone.Crypto lending changes the dynamic. Companies like Celsius Network and FTX — both now in bankruptcy — paid interest on crypto deposits, and lent out crypto assets to borrowers.a coin by the exchange. The borrower owns the coin, and the exchange is owed money from the borrower while also owing money to the depositor.
Effectively, an asset of one coin has become an asset of one coin plus two liabilities of one coin plus two receivables of one coin .assets worth 1 bitcoin. If the actual coin is lost and the borrower defaults, then the borrower and the exchange, and possibly even the depositor can all end up losing 1 bitcoin.
In traditional finance, central banks can step in to prevent such contagion. In crypto, however, there are no such macroprudential overseers.thing ever. Any time something’s created for a functional financial purpose — like stock, bonds, oil contracts, houses, you name it — there will always be people who engineer derivations of those things purely to make money.Perhaps the leverage, and the subsequent contagion, was inevitable and foreordained.
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