4 things to know as cryptocurrencies such as Bitcoin (and stablecoins) melt down
As the old maxim goes, sometimes the bigger they are the harder they fall.
Bitcoin and other cryptocurrencies surged during the pandemic, turning many amateur investors into millionaires, on paper at least. Bitcoin, for example, hit an all-time of nearly $68,000 in November.
Today, it's trading at less than half that amount as part of an intense sell-off that has accelerated in recent weeks.
It's been even worse for an area of cryptocurrencies called stablecoins, in particular one called TerraUSD that has tumbled hard.
Here's a look at what's going on.
So why are cryptocurrencies down so much?
Put simply, cryptocurrencies got caught up in the maelstrom affecting broader markets.
Stocks, bonds and other assets have tumbled in recent weeks as investors fear the Federal Reserve will need to raise interest rates aggressively to fight inflation, raising the prospect of a recession.
The falls in broader markets have affected cryptocurrencies, with Bitcoin down more than 20% in the past two weeks.
The selloff has been worse for some of the newer cryptocurrencies such as Dogecoin, which started as a joke and then took off, in part, thanks to the support of billionaire Elon Musk.
It's a stark reversal from a few months ago, when actors such as Matt Damon and Larry David were pitching crypto companies in Super Bowl commercials.
Wasn't Bitcoin supposed to be a hedge against inflation?
Yes, but it hasn't turned out to be one, at least so far.
Bitcoin was the first cryptocurrency and is still the most popular of them all.
Proponents of Bitcoin had long touted the digital currency as an inflation hedge, in part because there is a finite amount of it.
But Bitcoin has tumbled hard, along with stocks.
If Bitcoin was seen as a true hedge against inflation, it should be rallying given that inflation is at its highest in decades.
"A lot of people thought it would be an inflation hedge, but there's really very little data to prove that," says Randy Frederick, a managing director at Charles Schwab who covers cryptocurrencies. "Most recently, it has not moved up as the market has moved down. Had it been an inflation hedge, it might have done that."
In fact, Bitcoin is reacting just like any other riskier asset such as stocks.
Still, the argument of Bitcoin as an inflation hedge is not quite dead either, experts say.
Bitcoin may be the oldest of the cryptocurrencies, but it has only been around for just over a decade.
That means analysts don't have a lot of historical data. Frederick, for instance, says we'll know a lot more about how Bitcoin behaves through more market cycles.
What about stablecoins?
Cryptocurrencies have spawned offshoots and led to more sophisticated – or as some regulators see them, dangerous – assets.
Stablecoins such as tether or USD Coin are a type of crypto that are gaining in popularity.
Most stablecoins are meant to be backed by real assets. That means that for every dollar-worth of a stablecoin, the exchange or the seller would need to set aside the equivalent in a real fiat currency, such as the dollar, or the equivalent amount in an easy-to-trade security such as government bonds.
That's what is supposed to make them more "stable." If the buyer of the stablecoin wanted to cash out of that virtual currency, it should be easy since the exchange is supposed to have the money at hand, similar to how bank customers expect to be able to withdraw their money at any time.
But regulators have long questioned whether exchanges really do keep those hard assets aside in an account. Moreover, stablecoins have created their own offshoots.
One of them, TerraUSD, has run into big trouble in recent days. TerraUSD is known as an algorithmic stablecoin because it relies on financial engineering to maintain the 1-to-1 peg between the stablecoin and the backup assets.
TerraUSD is even pegged to another cryptocurrency called Luna.
The stablecoin cratered to 14 cents as of Friday, well below the $1 it should theoretically be fetching.
Pat Tschosik, a senior portfolio strategist with Ned Davis Research, says TerraUSD's troubles could be part of a potential winnowing of cryptocurrencies.
"It's still really young," he says, of crypto. "You know, this is still a developing area. There is going to be speculation. There is going to be booms and busts along the way, and this is all still new."
So where do we go from here?
More broadly, the outlook for cryptocurrencies will likely continue to be tied to broader market sentiment.
But the falls in cryptocurrencies and the collapsing value of TerraUSD stand to alarm policymakers such as Treasury Secretary Janet Yellen and Securities and Exchange Commission Chair Gary Gensler.
That may lead to more regulation of cryptocurrencies in general.
Sustained falls in cryptocurrencies could also raise doubts about the future of the virtual money more broadly, just when there had been signs that it was trying to mature, with more and more professional investors starting to trade them.
Last month, Fidelity, the largest provider of retirement plans, announced it would allow employers to offer Bitcoin in 401(k) plans, although the Department of Labor has cautioned employers against doing that.
Still, cryptocurrencies also have a lot of fanatical followers who are used to steep selloffs and reversals, and many of them believe that this is a short-term decline.
Tschosik from Ned Davis Research, for example, is "long-term bullish on Bitcoin," he says. "We still see the acceptance of it continuing to expand."
He points to millennials, for example, who want to invest in cryptocurrencies because they seem as as a "legitimate option."
Not everybody agrees, however, leaving the future of cryptocurrencies uncertain.
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