Does the Crypto Crunch tell us more about the value of money?

If you grew up in a Christian tradition, which has often had an ambivalent relationship with money, you would have been taught that money is worthless on doomsday.

Personal virtue is known as worth something that gets you through the pearly gates, but money itself is worth nothing.

When doomsday would be was never made clear, but anyone who saw the global financial crash of 2008 must have thought it could be it. The realization that one’s hard-earned money could evaporate in a bank run felt like some sort of monetary Armageddon was imminent.

If you had asked the largest bank in the UK (like me) around 2008 if their corporate accounts were ever guaranteed to any degree against such a run, they simply wouldn’t answer the question.

Like a somewhat mystical priest, the answer came back in a gnomic but optimistic evasion. “It would be highly unlikely that such a run would ever happen with such a well-funded bank,” was the reply. They didn’t want to leave you with a document containing a legally binding promise, nor did they want to scare you.

Behind the crash of 2008 was a piece of convincing, but erroneous thinking. If you spread the risk effectively enough, you can take on a debt obligation. (Actually, a pile of risky investments made less risky.) That was and remains true, but only if you consider an infinitesimal economic environment. Since all markets in the world represent a finite system, while risk spreads continue to expand, that risk starts to circulate in a circular manner. Despite spreading the risk, that risk is no longer diluted.

As a result, the normal distribution, or bell curve, which says Black Swan events are highly unlikely, no longer holds. Instead of a thin tail curve (as the normal curve usually is), you get a fat tail reflecting the real risk and unavoidable nature of 2008. In mathematical parlance, events believed to be statistically independent had lost their independence and were now highly covariate.

Now, about 14 years later, as of 2022, a similar problem started to arise. Terra Luna
LUNA
was designed to be a stable currency, but instead of actually being based on a certain number of dollars, there was an algorithmic component to it, and one with a somewhat circular piece of engineering.

There had been a number of white papers around 2021 suggesting similar types of mechanisms, but all had a notable weakness.

With a circular relationship between the financial engineering inputs and outputs, the stability of the system was a bit of an illusion. As in 2008, that circularity was apparent to the few who paid attention, but to those who were not, it came as a shock.

As the crash unfolded, Bitcoin
BTC
was sold from the Luna treasury to try and support the stable currency, according to the plan. As a result, a lot of Bitcoin was dumped into the market and Terra Luna failed to survive. When Tera Luna ran out of Bitcoin to sell, Do Kwong, the controversial and very well-behaved mastermind behind the stable coin, could no longer hide his panic.

The abundance of Bitcoin helped spark a bear market in crypto in general. 70% of bitcoin’s value was wiped out and the Tera Luna coin was nearly worthless. The infection had spread.

So what can we learn from the events of mid-May?

There are those crypto skeptics who say such a day of judgment would always happen, but not because they read the white paper and found circularity.

To them, the crash proves a more atavistic, almost biblical point, which is that cryptocurrency started out of being worth nothing, and therefore must return to its true origin of being worth nothing at a later stage. Such skeptics point to a token’s inherent lack of value, but often fail to understand the market dynamics that create value and that the same can be true for any currency.

After all, Nixon initially temporarily and then permanently abolished the gold pin that supported the US dollar, and the US dollar survived. Aside from a little inflation, you wouldn’t know the pen was gone.

Sometimes the naysayers point to a fiat currency and the controlling authority behind that currency to guarantee its value. This also makes no sense.

For a long time in economic history, salt was considered the perfect tradable sign of value, and although it was infinitely present in the sea, there was no controlling authority behind it.

Perhaps the most important thing to remember is that in the biblical conception of judgment day, time stops completely and there is no life after that. But human life and currency markets are not made of the same material. Things crash and reboot. The market continues albeit with a lower baseline and a painful past correction, but the market is alive to fight another day. Crypto, despite his recent carnage, will continue. Terra Luna stable coin on the other hand, and the circular algorithm, will be in eternal damnation.