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18 May 2022 | By Richard Ahern – The cryptocurrency market has crashed. Billions of dollars have been vaporized. But there is a valuable lesson crypto investors can learn from this.
The entire crypto market has suffered an extreme sell-off, with Bitcoin (BTC) down around 10% for the week and almost 25% for the month. Accompanied by Ethereum (ETH) and Cardano (ADA), which are down 30% and 37% for the month, respectively.
It got way worse:
All things considered, those investors were arguably the lucky ones compared to some crypto traders who literally lost their entire investment! The most infamous coin of the week was undoubtedly Terra (LUNA), supported by its stablecoin UST, which plummeted 99.99% in one week, essentially becoming worthless.
As the name suggests, stablecoins are designed to solve the common volatility problem in crypto markets by pegging a digital token to a regular fiat currency like the dollar. Crypto markets are known for their vicious volatility, while standard currencies remain relatively stable, being backed by the central bank and government that issues them.
So, what happened to Terra?
The Terra blockchain relied on its UST stablecoin maintaining a price of one US dollar. Still, on Monday, May 9, UST depegged from the dollar, sending the entire Terra ecosystem into free fall.
The Terra (LUNA) coin went from around $90 to a fraction of a cent in a matter of days.
This is tragic:
“I lost my life savings,” one Terra investor commented in a forum, and others voiced their fears of becoming homeless after betting vast amounts of money on the coin.
The coin crashed so rapidly that many crypto exchanges halted trading, meaning some investors could only watch in despair as their savings evaporated before them.
As a result of widespread fear in the crypto space, the entire digital currency market went into a frenzy of panic-selling. Billions of dollars in cryptocurrency have been erased.
Let’s put it in perspective…
At the beginning of May, the total cryptocurrency market was worth almost $1.8 trillion; by May 12, it was only worth $1.2 trillion. It seemed a distant memory from November 2021 when the crypto market grazed the $3 trillion mark.
Every catastrophe has an important lesson:
The lesson should be clear to all investors: good times don’t last forever in the financial markets. When everyone at the water cooler is talking about investing in a particular asset, that’s a solid signal to sell because the market is likely topping.
More specifically, to crypto investors, the message is loud and clear: this market is volatile!
The technology is still in its infancy, and there are many wrinkles to iron out. One thing for sure is that just because a coin is described as “stable” doesn’t mean it is! Just ask the Terra community about what happens when the stablecoin decouples from its point of stability.
Secondly, investors have to learn that crypto is one of the riskier assets out there because it’s based on virtual technology and not anything physical.
Compare crypto to other asset classes:
Commodities (gold, silver, oil, etc.) and real estate are all physical things you can touch, and no matter what happens, you can be confident that their value will never fall to zero.
Equally, owning a share in a company gives you a piece of that business — a business that owns real-world assets and generates cash flow. So even when a company goes bust, which is unlikely, shareholders will usually still get something back when the assets of that business are sold.
In sharp contrast to cryptocurrency, fiat currencies are backed by central banks and governments with a vast number of powerful tools to keep that currency stable. So short of a complete government collapse from something like war, you’re unlikely to lose all your money by investing in fiat currencies.
Cryptocurrencies can become utterly worthless in days if the underlying technology behind the coin breaks; just ask Terra investors. Unlike real-world commodities like gold, virtual crypto coins can have infinite supply; and by the laws of supply and demand, anything in unlimited amounts won’t hold much value.
Here’s the bottom line:
With all that said, great risk can come with great reward. Cryptocurrency markets can provide astronomical returns that other markets can only dream of — on the flip side of the coin, you can lose 100% of your investment.
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