Soothing the crypto burn

I’ve been rooting for the crypto market to crash and burn. Not because I was resentful to see so many people get rich from it (though there were moments). But because I don’t understand it, what value it serves, or what problem it solves.

I spent the last 12 years assuming that crypto would go away. Now it might. Or at least it might become a smaller part of the financial market.

But now I’m worried. After a decade of drawing in investors, minting new millionaires and billionaires, and inspiring passion for investing among a new tech-savvy generation, I fear the consequences of it crashing and burning. Investors are in danger of learning the wrong lessons about risk.

I’d feel guilty for rooting against crypto if its fall tips the economy into a recession. But it doesn’t seem that FTX.com or the crypto market poses a systematic risk; by design, crypto is supposed to lie outside the traditional financial markets. When there’s a failure in the bond market it’s bad because it touches everything and the whole market melts down. That’s not the case with crypto.

But there are still reasons to worry about what the FTX situation portends for investors.

The whole crypto market is in trouble, and people are losing money. It’s especially worrying that many of the newest investors to crypto, who bought high and watched it fall, tended to be lower-net-worth investors, some new to financial markets.

The value in crypto was supposed to be that it offered a hedge to the dollar or more conventional parts of the market. Or that it would hold up in value if everything else fell. But an asset that offers that kind of hedge is rare; most assets are somewhat correlated, especially when the market drops.

Rareness normally means an expensive asset that offers a lower return. You pay a big price for that kind of safety, and it’s hard to find. The fact that crypto offered such high returns indicated it was never a good hedge. Anything that seems to deliver very high returns comes with the risk you will lose your shirt at the worst possible time.

Another worry is the blow to the credibility of the financial system. Instead of being more explicit about the true nature of the risk, the system has instead gone along with the idea that it’s possible to get something for nothing. If people want to speculate in risky assets that might crash and burn, that’s their right, so long as they were never misled or pose a greater systemic risk. But it’s a failure of any fiduciary that allowed crypto assets in a 401(k) plan. Offering that option indicates that the fiduciary believes crypto is a prudent long-term investment for money people will need in the future.

The Department of Labor expressed concern about crypto in retirement plans earlier this year and planned an investigation. Their concern may have been too little, too late. This leads to a loss of trust in the system, and that has consequences. Some investors may reduce their investments or shy away from investing altogether and miss out on returns in the future on more reasonable assets such as index funds. Instead, the lesson people should take from this is not that markets are rigged, but that extremely risky assets probably don’t belong in your retirement portfolio.

The fall in crypto is happening at the same time other tech companies are seeing their valuations tank. They were probably due for a correction too, but it’s no coincidence. A rise in interest rates and inflation tends to take the air out of all kinds of risky assets. A bigger concern is if investors get too nervous and that spills into other assets, bringing the whole stock market down.

So far that’s not happening. Markets appear to be moving more on macroeconomic news than what’s happening in crypto. But rising rates pose many risks. The crypto crash is a symptom and not a cause of a riskier environment that should serve as a reminder that financial markets don’t offer any guarantees.