In recent days, we have witnessed the crisis that broke out after the collapse and loss of value of many cryptocurrencies. Experts speak of losses of up to 200 BILLION dollars that vanished due to the plummeting of many currencies considered strong and the disappearance of low-value coins.

What does the fall of cryptocurrencies mean?

For many, a reason for happiness; for others, a cause for concern and for experts in crypto investments, nothing surprising. This is how the investors experienced the successive falls of cryptocurrencies such as Bitcoin, Solana, Ether, and the almost definitive evaporation of Luna in recent days.

Traditional media, defenders of the status quo, Fiat currencies, and the centralized economy are feasting on the plummeting of the crypto market. Many of them even claim that the bubble has burst, that the market is over and that this is only going to get worse. For their enjoyment, the complete disappearance of Luna and the stable coin UST, the currencies of the Terra project, gives them much to talk about, especially since not even a stable coin paired with the dollar could be saved. 

On the other hand, the crypto world is going crazy. There is panic among many minority investors, who have lost large sums of money in this highly speculative market. Now, they are withdrawing the assets in exchange for Fiat money, hoping not to lose it all in the market crash. On the other hand, the savviest investors are taking advantage of free-falling prices to buy undervalued assets, hoping for a recovery that will allow them to make money. But the crisis is much deeper than the simple supply and demand market, and we will try to look at it in detail.

The traditional economy affecting the virtual economy

As much as fans and defenders of cryptocurrencies believe that the digital and decentralized economy is beyond the scope and effects of the stock market, it's a fact that the current situation of the world's economy is strongly affecting cryptos.

To understand this, we need to look at the world economy. The first pillar of the crisis is two years of the pandemic. During this period, the world's economies were forced to issue currency to alleviate the crisis. Regardless of whether this was good or not, the printing of money always results in inflation. The excess of issuance has plunged the world economy into the worst inflationary crisis in 30 years.

On the other hand, the war between Russia and Ukraine has put many European economies in a difficult situation since the war confronts the two largest grain producers in the region, affecting the prices. Also, Russia responded to the sanctions imposed on them by reducing the gas and energy exports to Europe, especially NATO countries, which has sent prices through the roof and forced the energy transition in West Europe.

This European crisis has caused the Euro, a currency considered strong, to lose almost 20% of its value and is just short of reaching parity with the dollar, setting off the alarms in the European stock markets showing a downward trend.

All of this is affecting the behavior of many cryptocurrency investors. When crypto assets boomed, these decentralized currencies were expected to be a safe haven during times of crisis since, in theory, they were not tied to traditional economies. However, we have seen that the crypto market has had a downward trend since, in December 2021, it reached its maximum peak in the historical capitalization of this market with a value of 3 trillion dollars. Today, this market has lost close to 40% of its value. Close to 2 billion dollars were taken out of the ecosystem and probably invested in traditional markets such as real estate, precious metals, and gold.

Although this goes a little against the expected behavior of the crypto market, for the most experienced crypto investors, this is a golden opportunity. They expect that the strongest currencies, such as the Bitcoin and Ether, recover and double their current value, generating incredible profits for those who refused to sell and instead bought more.

The fall of the Terra project

Not only the stock market and the inflation is to blame for this resounding fall. Although the crypto market had indeed been in recession for several months, the disappearance of the coins Luna and UST is what put the market in this free fall.

Let's start by talking about these two currencies. Luna and UST were the two currencies of the Terra project, one of the most stable projects with the highest capitalization in the crypto market. Just two months ago, Luna had reached its historical maximum with a value of 119 dollars per Luna. On the other hand, UST was the stable coin of the project, which maintained its parity with the dollar through its supply and demand relationship with Luna.

To understand why this fall was so shocking, we need to know that the Terra project was one of the most stable ones and investors had a significant trust in it. The Terra project had a market capitalization of 30 million dollars just a week ago, and today its two currencies have lost more than 99% of their value, and the capitalization of the project is under 1000 dollars.

If the project was so stable, what happened to these two coins? The first thing we need to understand is what is a stable coin. As its name indicates, it is a stable currency that emulates the dollar's value; one UST equals a dollar. There are several ways to keep those coins stable. The simplest is to have a reserve; there is a crypto coin for every dollar I have in my reserve. The other is to use unstable cryptos as backup value for stable coins; UST used this system, but unlike other stablecoins that use any other crypto in the market, its supporting asset was only Luna.

The system worked in a relatively simple way. When there was a lot of demand for UST, and it began to gain value, Luna was burned, and more UST was minted to lower its value and stabilize it. In the same way, when the value of the UST went down, they burned UST to mint Luna and stabilize it again. 

The problem started when the Terra ecosystem started to make a lot of profits. The more money there was on Luna, the more USTs were minted until there were so many that they could no longer be regulated with Luna's existence. As a result, the stable coin became more unstable, and its value began to fluctuate. At first, it was only a few cents to the dollar, and Terra, knowing this was not good, bought Bitcoins to re-stabilize the UST but was unable to do so. The whales were warry with the fluctuation and decided to sell their UST, increasing the difference between the coin and the dollar. To compensate for this instability, the system did what it was programmed to do, print Luna, but because of the basic supply and demand equation, the price of Luna crashed, causing both Luna and UST to sell off, causing both coins to lose their value.

The Terra fall also contributed to the Bitcoin fall. To rescue the Terra project, the owners tried to use their Bitcoin reserves; however, shortly after announcing this idea, the Terra wallets were emptied, and the offer to sell Bitcoins increased. Many of those Bitcoins were suspected of coming from the project. With the drop in prices, the miners decided to sell too. As a result, the price of Bitcoin fell, dragging other cryptocurrencies with it and generating a feeling of insecurity throughout the whole ecosystem.

Coinbase and the bankruptcy of the Cefi exchanges

Although the fall of Luna is very impressive, it's not what has upset investors the most, especially minority investors. What has really made many people take their money out of the crypto ecosystem was the revelation of Coinbase CEO Brian Armstrong. Coinbase is one of the many exchanges that serve to sell or buy cryptocurrencies. Armstrong recently revealed that his company had lost nearly 430 million dollars in the first quarter of this year, which spread rumors of possible bankruptcy. Armstrong assured that such a risk did not exist but that, if it did occur, they would use the users' assets to settle the company's debts and tax obligations in a similar way as a bank would do in the event of bankruptcy.

People were terrified that in a supposedly decentralized system without the control of any entity, a company could take away their cryptocurrencies. This triggered massive sales and withdrawal of assets from Coinbase wallets. The company lost more than half of its users since the announcement. Other exchanges had already seen red numbers in the number of users for a few months. Today the company has lost more than 80% of its shares.

We must clarify that Cefi, or centralized finance, has existed in the crypto ecosystem for a long time. Exchanges are the safest way for novice and minority investors to enter this ecosystem. These institutions are very similar to traditional banking, allowing people to have your wallet and guarding it for you. I feel intermediaries in the transactions just like a bank would. In exchange for security, you would not have in the decentralized system where you are solely responsible for your money.

Discover the differences between the Defi and Cefi system >

El Salvador looking into the eyes of the bankruptcy

On September 7, 2021, El Salvador became the first country to accept Bitcoin as legal tender. Unfortunately, what was world news has been a failure within the borders of the Central American country since the general public has not adopted this cryptocurrency for its current use and continues to prefer the dollar system.

In addition, regulatory entities of the economy such as the International Monetary Fund have repeatedly asked the government to withdraw this currency as legal tender. Due to the denials of President Najib Bukele, The banks lowered El Salvador's credit rating to a high-risk country, which is why many banks are reluctant to make loans.

Regardless of this, President Bukele continues to insist on the advantages of cryptocurrencies and has taken advantage of the price drop to buy even more Bitcoins with taxpayers' money. As a result, El Salvador is one of the largest owners of Bitcoin, with 2,300, which, at today's value (May 20, 2022), is equivalent to more or less 67 million dollars.

Considering that most of El Salvador's assets are invested in a highly volatile and unstable currency, this government's debt bonds have lost 40% of their value. As a result, many investors consider it unlikely that El Salvador will be able to meet its next debt payment in January 2023. This has caused El Salvador to lower its risk rating from B to CCC, like Greece at the worst moment of its economic crisis. 

On the contrary, the Salvadoran government defines itself as Dimond's hands and refuses to sell its Bitcoins, and clings more and more to the possibility that a historic rise after the crisis will put them in an excellent economic situation.

Conclusions: Crypto investments, a market not suitable for the weak

Playing the futurist or the crystal ball in economic matters is always risky, especially in the cryptocurrency market, where it's even more challenging to draw conclusions and talk about what could happen. We have already seen that the instability of the markets can make everything change from one day to another, and what was giving you millions yesterday today falls, and all your money vanishes into thin air. However, we can make some general observations of what seems to be the natural consequence of a fall as resounding as this.

The first consequence could be the reduction of junk tokens or coins that have not reached a real capitalization in the crypto market. These tokens tend to be low-value and high-risk coins, so investors are likely to abandon them in favor of more recognized coins, thus reducing the oversupply of cryptocurrencies in the market today (about 22 thousand with only 10 thousand active).

Another consequence may be the exit of novice investors and other inexperienced speculators who entered the crypto market without considering the risks of high possibilities of economic losses in cases of a fall like this.

A third is the downward trend in the use of exchanges. Many people have already realized that CeFis are too similar to traditional banks. In the world of cryptocurrencies, where it is so easy to lose your capital, having your money stored in an exchange where liquidity depends on users' wallets it's not exactly the safest idea, especially if the small print says that they can appropriate your capital to pay their tax obligations in case of bankruptcy.

As a fourth possible consequence, we will see a greater division in opinions about cryptocurrencies. On the one hand, the traditional economy will increase its attacks against this speculative and decentralized economy. On the other hand, the defenders of Bitcoin, who consider this type of crisis as normal and even expected, will defend the ecosystem even more and take advantage of it by buying cheap and waiting for the market's recovery. 

Finally, we will say that it is impossible to predict what will happen to the crypto ecosystem in the future, if it will be the end of the bubble or if the numbers will recover. For now, we will be attentive to the market's evolution and carefully observe how the crisis develops, always remembering that, in this crypto market, you cannot invest money you are not willing to lose.