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False economy

Thumbnail image for coyote-roadrunner-cliff.pngThis week, every cryptocurrency was unhappy in its own way. It has not been a good year for cryptocurrency speculators in general, but Wednesday was a disaster: almost all "major" cryptocurrencies crashed by about 25%, and even venerable bitcoin dropped by 14% (although it still is twice its 2017 peakl. Which sounds great until you realize that on November 10, 2021 people *bought* bitcoin for $68,789 and El Salvador has been "buying the dip" all year.

Especially notable were the losses among cryptocurrencies intended to stay pegged to the US dollar - "stablecoins" - which fell off a cliff, pricewise. One previously unfamiliar "stablecoin", Luna, dropped 99.7%, leading some posters in the Terraluna subReddit to post suicide helpline numbers.

Do not gloat. Heed Hamilton Nolan's warning at In These Times about the dangers when a class of young (mostly) men who hate government become angry, bitter, and hopeless.

First: what happened? You can value a company, as Warren Buffett does, by studying it: its business, market sector, competitors, financial stability, and prospects. There's always some element of uncertainty. New managers could derail the company (Boeing), new, well-funded competitors could enter the field (Netflix), new technology could overrun its business model, or it could be lying about its revenues - er, painting a rosier picture than is actually merited by the facts. If you have the mad skillz of Buffett (and his professor, Benjamin Graham), thinking through all that should lead you to a reasonable purchase price, and not overpaying allows you to profit from your investment at relatively modest risk.

However, a cryptocurrency is not a business, and it has no real-world usefulness. Like gold, which Buffett has never liked, it costs money to hold, it produces nothing, and, "You can fondle it, but it will not respond". But at least gold has some industrial uses. Cryptocurrencies have none; they are the currency equivalent of being famous for being famous, held aloft only through fear, greed, and mythology. In any crisis, toilet paper, chocolate, cigarettes, booze, or toothpaste are all more useful currencies.

Luna is the most interesting. Here's how Coindesk describes its collapse: "A change in market dynamics caused Luna prices to snap at a breakneck pace. Luna plummeted through several support levels as terraUSD (UST), a Terra-issued stablecoin that's meant to be priced 1:1 to the U.S. dollar, lost its peg."

Let's pick this apart. "Market dynamics" could simply mean "interest rates are going up", which drives money away from the riskiest assets, which sets off a cycle of selling.

"Support levels" is a term for a tealeaves-reading approach to stock market pricing called technical analysis. Proponents believe that the shapes of price charts over time have significance in and of themselves. It has nothing to do with underlying value, Effectively, the fundamental claim is that past performance predicts future results, the exact opposite of what every financial product is required to tell prospective buyers. It would be complete nonsense, *except* that so many people believe in it that those patterns really do move markets, at least short-term. So "breaking support levels" becomes "let's panic and sell, ferchrissake!"

HowToGeek tells us that UST is the stablecoin on the Terra blockchain. Terra is a company providing "programmable money for the Internet", and its blockchain "brings DeFi to the masses". DeFi is short for decentralized finance, and its appearance means we're entering web3 territory - the folks who want to reclaim the Internet through redecentralization. Let's leave that part aside for today.

Traditionally (!) what makes a stablecoin stable is that for every coin (for example, Tether, which also slipped, to $0.95) its issuer holds an actual $1 in its reserves. However, it turns out there is a *second* type of stablecoin, which is backed by an algorithm rather than an asset representing some government's full faith and credit.

So the UST "stablecoin" is pegged to Terra's Luna stablecoin, and the idea is that an algorithm - a smart contract - keeps them pegged to each other by buying, selling, and converting them so they both reliably stay at a value of about $1. This is the theory.

It *sounds* like a folie à deux - that is, a shared delusion in which the partners reinforce each other's belief but neither leads the other closer to any form of outside reality. Apparently enough people distrust governments so much that algorithm! seems appealing and five weeks ago Luna's market cap was $39 billion more than it is now. Yes, money is flowing away from stock market risk, too, but more slowly for the reasons outlined above. A chart at the Motley Fool shows clearly that cryptocurrencies aren't a useful hedge against this.

Bottom line: algorithms do not make a coin stable, and if you don't understand what you're buying, don't buy it.

None of this means cryptocurrencies are finished. It doesn't make them good "investments" to "buy on the dip", either. It's just one more piece of mess in an ongoing expanding experiment that has been highly profitable for a few people, and rife with fraud and market manipulation for many more. Just say no.

Illustrations: Wile E. Coyote makes the mistake of looking down as he runs off the edge of a cliff.

Wendy M. Grossman is the 2013 winner of the Enigma Award. Her Web site has an extensive archive of her books, articles, and music, and an archive of earlier columns in this series. Stories about the border wars between cyberspace and real life are posted occasionally during the week at the net.wars Pinboard - or follow on Twitter.


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