Dave Sather: Crypto’s collapse and you

The rise of cryptocurrency is something we watch with intrigue. However, we are unmotivated to put money in the category.

Despite the frequent “crypto winning lotto ticket” mentality, we have a different perspective. Once upon a time, the concept of sending money around the world via Western Union was a revolutionary concept. It changed the way we move money. In our opinion, cryptocurrency is a modern interpretation of Western Union.

As such, it was surprising to see this asset category skyrocket with a supposed $3 trillion peak valuation.

The fall in the traditional financial markets has grabbed everyone’s attention. However, the collapse in cryptocurrency has been significant. The best-known digital currency, Bitcoin, is down 23% in five days with a 68% plummet since its peak. Others have fallen harder.

At its peak, the crypto market was worth $3 trillion. Today, it is down 65%. Anytime you see $2 trillion in supposed value evaporate there will be sizable ripples.

This volatility and lack of regulated structure is testing the legitimacy of crypto as a true investment category.

When the broader crypto market skyrocketed, people chased the category like moths to a flame. Often, they leveraged their crypto lottery tickets and borrowed money to buy crypto from brokers.

One of these exchanges is Celsius. It is a “decentralized” bank. It lends and borrows crypto much like a traditional financial institution. Celsius offered exceedingly high interest returns to crypto depositors of more than 18% per year.

On June 14, Celsius froze access to 1.7 million depositors and terminated transfers or withdrawals. Investors had deposited more than $11 billion with Celsius attracted by the unbelievable interest rate paid to depositors. Now they are stuck.

On the same day, Binance, one of the world’s largest crypto exchanges, halted trading.

This spooks investors, traders and casual observers.

When speculative investment categories like crypto collapse, rarely is the volatility limited to that category. Often, cryptocurrency owners put them with brokerages who encouraged borrowing to buy even more crypto assets.

When they collapse, the lending broker issues a margin call requiring an addition of value or liquidation of assets. This leads to a decline in crypto asset prices followed by selling which creates a downward spiral in crypto prices.

The leverage does not stop with just crypto. Many investors speculating in digital currency, borrowed against traditional stocks or bonds as collateral. When crypto collapsed, it invoked a margin call where underlying brokers forced investors to either add something of value or have stocks and bonds liquidated.

This is where we are today. Widespread forced liquidations. Crypto has collapsed, exposing the number of people using significant leverage to boost returns. This caused a huge wave of liquidation across all asset classes. Indiscriminate selling causes all asset prices to decline regardless of the merits of the business model or the profitability of the assets.

There are corollary stories unraveling as we speak. When an asset category spikes, everyone wants to be on the “winning team.” Schemers and con artists know this blind desire to be with the cool kids opens the door for Ponzi schemes, scams and con artists.

When prices fall precipitously, people start asking questions. They want their money back. When there is a “run on the bank” you often expose schemes and crooks. This creates fear and unease. In the process even more people run for the door.

What should be learned from this?

• If it sounds too good to be true, it is.
• If you cannot determine how a business or asset creates value, avoid it.
• The world of cryptocurrency has no regulation. It is ripe for sloppy, or overly aggressive, business practices.
• When people get greedy, con artists and crooks will take your money.
• Leverage doesn’t make you right or wrong, it simply magnifies the amount to which you are right or wrong.
• If you don’t borrow, it is virtually impossible to get wiped out.
• There is no silver bullet for investing success. It requires discipline, focus and common sense.

The good news?

Legitimate businesses still make money and will deliver value for long term investors. The volatility we are experiencing is the result of people being cashed out who should never have been in questionable assets. Although this process takes time, things will stabilize and the long-term owner of profitable businesses will benefit.

Dave Sather is a Certified Financial Planner and the CEO of the Sather Financial Group, a fee-only fiduciary investment management and strategic planning firm. His column, Money Matters, publishes every other week.