If you had invested £ 100 (US $ 122) in Cryptocurrency Luna a month ago, you would have been quietly confident that you had placed a wise bet. But the price of the lunar has dropped dramatically since then – at the time of writing, the 100 is worth about 4p (¢ 5).
Luna was by no means the only victim in a week where the cryptocurrency was 30% lower. Some have recovered to a certain extent, but it still represents an overall seven-day loss of US 500 500 million (£ 410 million), raising questions about the existence of the market.
The crash was probably triggered by a financial “attack” on the Stablecoin Terra (UST), which was supposed to match the US dollar but is currently trading at just 18 cents. Its partner currency, the luna, later collapsed.
A Attack Attempts to trigger such highly complex, and specific effects involve multiple trades in the crypto market – which can provide significant gains to the “attacker”.
In this case, these businesses caused Terra to collapse, which in turn brought down his partner’s currency, Luna. Once it was noticed, it caused panic, which led to the withdrawal from the market, which in turn caused further panic. Some (but not all) stablecoins rely heavily on perception and confidence – and once shaken off, a big fall can be effective.
More importantly, the recent major downturn in cryptocurrencies has raised questions about how stable Stablecoin is. After all, they are designed to keep virtually zero instability while maintaining a “peg” in some other underlying resource.
Yet the effects seen this week spread across the crypto space, resembling a one-day loss – or arguably worse – a “black Wednesday” for crypto (Black Wednesday was the day when speculators collapsed in 1992 to the value of the pound). Even the top stablecoin coin lost its peg, falling to 95 cents on the dollar, probably showing the need for control. If stablecoins are not stable, then where is the safe place for crypto?
How investors respond will be the key to the future of cryptocurrency. We have already seen panic and frustration, with some comparing the accident to a traditional race on shore. But as banks run, customers begin to worry that their banks will be unable to pay them, instead their money has become worthless.
A more accurate comparison is with the stock market crash where investors are concerned that the stocks and shares they hold may soon become worthless. And so far, the response to this crypto crash has shown that a large portion of crypto holders view their investments the same way.
Despite historical price volatility, investors often have a fundamental assumption in their behavior: that the value of the asset will increase and continue to do so. Investors do not want to miss out on this opportunity. They see an increase in wealth, consider it a “sure thing” and then invest.
Often overwhelmed by initial success, investors can then invest more. Combine this with social media and the fear of losing “inevitable” profits, and investments continue.
Simply put, many will invest in cryptocurrency because they believe it will make them richer. There is no doubt in this belief.
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But another motivation for investing in cryptocurrencies may be their belief in the transformational nature, the idea that cryptocurrencies will eventually replace traditional forms of financial exchange.
For these investors, any increase in the value of a cryptocurrency is a demonstration of the growing power of cryptocurrency over conventional money. But similarly, a significant fall in the value of crypto is not just a financial loss – it is a norm.
At the same time though, this ideological position makes an investor group less likely to be sold in the face of any sharp fall. And it is this group that can still provide hope for the sector.
In the established stock market crash we talk of a return to the “basic price”. The basic value of crypto is often assumed to be zero. However, there are probably at least some basic values that are based on faith. The size of the pool of investors who own cryptocurrencies because they believe in its long-term future and the promise of a new currency can determine the value of cryptocurrencies.
In fact, if we consider cryptocurrency investors as different groups with different motivations, we can better understand the behaviors we are seeing. Investors may be reassured that we’ve seen the worst of this crash and better times ahead. But as any financial advisor will tell you, like any other market, crypto is not guaranteed.
Gavin Brown, Associate Professor of Financial Technology, University of Liverpool; Richard Whittle, Cape Policy Fellow, UCL, and Stuart Mills, Fellow of Behavioral Sciences, London School of Economics and Political Science
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