Offchain: Lessons from the GFC

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Crypto firms are collapsing under the weight of bad bets, excess leverage and poor risk management. What can the GFC tell us about what comes next?

The implosion of the LUNA-UST ecosystem in May was the starter’s pistol on a rapid-fire and comprehensive bout of deleveraging that has left the crypto industry in the grips of its worst crisis since… well, ever.

Sure, the 2018 ICO meltdown was a big deal, but crypto’s obscurity at the time meant the collateral damage was comparatively contained. Obviously there was the occasional investor who lost their life savings after betting it all on Dentacoin – putting the dental industry on the blockchain! – but at a basic level everyone knew how risky these gambles were.

The collapse of the CeFi crypto lending industry is challenging precisely because it was built on an image of bank-like security. The crypto economy is volatile, but trust your coins to us and we’ll make sure you earn a nice, reliable 12%. How are we achieving those returns when the basic cash rate is close to zero? Don’t worry about it!

Well, we made our bed and it turns out we made it out of snakes, spiders and a pool of open sewage. The GFC comparisons feel apt, but what can TradFi’s 2008 meltdown tell us about the recovery?

 

Bailouts are a mixed blessing

In some ways the biggest story of the GFC was the governmental interventions to save distressed banks. (Hell, it’s baked into Bitcoin’s genesis block). Despite these actors being, at best, criminally incompetent, their importance to the financial ecosystem writ large was such that central banks had little choice but to step in and stop them from taking the country into the bin with them.

Right now we’re seeing Binance and FTX playing the part of crypto’s central bank, extending lines of credit, short-term financing and straight up acquisition offers to distressed companies.

During the GFC, survival of the company was prioritised over the customer. As a result, most financial firms brushed off the GFC as if it didn’t happen, baking in some of the worst parts of the status quo. (See hazard, moral). Crypto still has the chance to invert the equation.

The old guard may not survive

The aftermath of the GFC saw a generational reorientation of the economy. As capital markets reset, an opportunity was opened for redistribution to ideas and companies whose time had come: the titans of web 2.0.

Outfits like Binance and Coinbase may appear invulnerable, but their fortunes were built on the bones of crypto 1.0: spot and derivatives trading. At some point the crypto industry will leave behind the casino and start drawing value from actual blockchains and real world use cases. Could a Titanic-grade deck clearing usher in the next wave of crypto behemoths? More to the point: are those behemoths in the room with us right now?

Regulation could save (or stop) us

While the regulation introduced in the wake of the GFC left much to be desired, it at the very least restored confidence and shut down the most obvious path of contagion: undercapitalisation.

Crypto has long seen regulation in a negative light, the responsible adults come to shut down the decade-long party. But it’s now pretty clear something needs to be done to stop the partiers from doing keg stands on top of the patio. Transparency and consumer protections are required.

The risk, as always with regulation, is overreach – producing a chilling effect on innovation and new company formation while simultaneously entrenching established players. What would crypto be without the supernova-esque levels of creative destruction that have taken us this far?

The worst might not be over

In 2008, the S&P 500 dropped 50% before bouncing and stabilising. A few months later it crashed again, making new lows and convincing most people that the next step in the process was a collective reversion to pre-agricultural hunter-gatherer society.

We’ve seen enough boom-bust cycles in crypto that this story is at least vaguely familiar. And given how radioactive the current crypto climate is, going lower is a very real possibility. All we can hope is that the next part of the tale – a 13 year run to the stars – may also be in our future.

Luke from CoinJar

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