Commentary

Crashing Crypto: Is This Time Different?

By Paul Krugman

Last week TerraUSD, a stablecoin — a system that was supposed to perform a lot like a conventional bank account but was backed only by a cryptocurrency called Luna — collapsed. Luna lost 97% of its value over the course of just 24 hours, apparently destroying some investors’ life savings.

The event shook the crypto world in general, but the truth is that this world was looking pretty shaky even before the Terra disaster. Bitcoin, the original cryptocurrency, peaked in November and has since declined by more than 50%.

Here is one way to think about that decline. Almost everyone is concerned about the rising cost of living. The Consumer Price Index — the cost of a representative basket of goods and services — has gone up about 4% over the past six months. But the cost of the same basket in bitcoin has risen around 120%, which means inflation at an annualized rate of about 380%.

And other cryptocurrencies have performed far worse. Two cities — Miami and New York — have introduced their own cryptocurrencies, with enthusiastic support from their mayors. MiamiCoin is down more than 90% from its peak, and NewYorkCityCoin is down more than 80%.

By now, we have all heard of them, but what exactly are cryptocurrencies? Many people — including, I fear, many people who have invested in them — probably still don’t fully understand them. Saying that they are digital assets doesn’t really get at it. My bank account, which I mainly reach online, is also a digital asset, for all practical purposes.

What is distinctive about cryptocurrencies is how ownership is established. I own the money in my bank account because the law says I do, and the bank enforces that legal claim by requiring, one way or another, that I prove that I am, in fact, me. Ownership of a crypto asset is established through what is known as the blockchain, an encrypted (hence the name) digital record of all previous transfers of ownership that supposedly obviates the need for an external party, such as a bank, to validate a claim.

What is the point of this kind of decentralized finance, and what purpose does it serve? Well, I’ll get to all that.

Though cryptocurrencies are currently way down, boosters — and as anyone who has played in this space can tell you, there are few boosters quite as boosterish — will reassure you that this has happened before. Bitcoin, in particular, has always bounced back from previous dips, and investors who HODLed (held on for dear life to their coins, despite falling prices) have ended up with huge capital gains. But there are reasons to believe that this time may be different.

In the past, cryptocurrencies kept going up by attracting an ever-growing range of investors. Crypto was once held by a small clique that often had the feel of a cult, motivated in part by a combination of libertarian ideology and fascination with the clever use of technology. Over time, rising crypto prices drew in large numbers of additional investors and some big Wall Street money.

And in the past year or so, crypto marketing has gone really mainstream, with endorsements from celebrities — including Matt Damon, Kim Kardashian and Mike Tyson — not to mention political figures like Mayor Eric Adams of New York and the (unsuccessful) Republican Senate candidate Josh Mandel, who declared his intention to make Ohio “pro-God, pro-family, pro-bitcoin.” Given all this, it is hard to see who else there might be to recruit into crypto investing.

One disturbing aspect of this marketing push, by the way, is that those who bought cryptocurrencies relatively recently — and have therefore lost a lot of money in the crypto crash — probably consist disproportionately of the kind of people most likely to be influenced by celebrity endorsements. That is, they are probably poorer and less sophisticated than the average investor and badly positioned to handle the losses they have taken over the past few months.

In any case, as we look forward, the value of cryptocurrencies will have to rest on their underlying economic uses, which are …

Well, that is just the thing. I have heard many discussions in which crypto supporters have been asked exactly what economic role crypto can play that isn’t more easily and cheaply achieved through other means — debit cards, Venmo, etc. Other than illegal transactions, in which crypto may sometimes offer anonymity, I have yet to hear a coherent answer.

As it is, cryptocurrencies play almost no role in economic transactions other than speculation in crypto markets themselves. And if your answer is “give it time,” you should bear in mind that bitcoin has been around since 2009, which makes it ancient by tech standards. Apple introduced the iPad in 2010. If crypto was going to replace conventional money as a medium of exchange — a means of payment — surely we should have seen some signs of that happening by now. Just try paying for your groceries or other everyday goods using bitcoin. It is nearly impossible.

And then there is El Salvador, which tried to force the process by making bitcoin legal tender and heavily promoting and subsidizing its use, in an attempt to make it a true medium of exchange. All indications are that the experiment has been an abject failure.

But can crypto really have become such a big deal without any clear economic rationale other than pure speculation? Can it really be just a bubble inflated by FOMO, fear of missing out? Those who question crypto’s purpose are constantly confronted with the argument that the sheer scale of the industry — at their peak, crypto assets were worth almost $3 trillion — and the amount of money true believers have made along the way proves the skeptics wrong. Can we, the public, really be that foolish and gullible?

Well, maybe the crypto skeptics are wrong. But on the question of folly and gullibility, the answer is yes, we can.