Welcome to the post-pandemic economic downtime! Everything is down, the stock market is down, the Fear & Greed Index is at an all-time low, bond yields are down, crypto is more than just down, it’s underground with bitcoin hitting below $30, 000 for the first time in a long long time.
In this article, I want to explain what the heck is going on in the markets because it is this kind of market that’s going to turn investors into traders. This is the kind of market that’s going to test your will to not lose money and it’s a reminder that in times like this, there’s not much any of us can do to run away but just wait until the pain is over.
I know it’s hard to imagine investing over a $100, 000 of your hard-earned money into something and then watching it magically wither away into less than $10 000, you’d probably cry. On Thursday, some investors took to popular social media platforms to shared their crypto portfolios, showing well over 86% down, I mean, the only thing that’s not down is real estate and that’s only because real estate moves really slow but the pain is coming there as well, perhaps.
One reason experienced investors are not letting this affect how they feel and how they invest is because they’re already trying to fathom what happened and understand why this is happening now.
I’m not a financial advisor and if there’s anyone who can tell you for sure, what’s going to happen tomorrow, I don’t know that person but I can intimate you historical data that shows what happens in times like these because the more we understand why this is happening the easier it is to continue investing and staying the course.
Let me break it down first, with the “explain it like I’m five” version of what happened this week.
This story started two years ago, so let’s rewind a bit; first, (yes, you guessed it) we were hit by a global pandemic in the beginning of 2020, which led to partial or, as it was in most cities around the world, total lockdown, everyone was to remain in their homes to play we their thoughts in boredom, and then, we began a two year party where we partied a little bit too hard!
Speculative tech stocks started to go into crazy valuations, companies that weren’t even making money yet had crazy stock values, NFTs that were extremely speculative were sold by the dozen, people were spending over a million dollars on pictures of a pets and comic characters, real estate went to over $400, 000 for the average home in the U.S and crypto went to the moon.
Now that we realize that this party can’t go on forever the buzz is starting to wear off and we’re now seeing who partied a little bit too hard and that’s the “explain it like I’m five” version of how we got here.
Now let me give you a little bit more of a technical breakdown of what actually happened this week:
One of the reasons is because in the CPI data (Consumer Price Index) for this week, economists predicted that we would have 8.1% inflation but we got 8.3% instead, with the major contributors to the inflation being food, rent, new car prices and airline tickets.
Whenever this kind of thing happens and inflation data comes out, there are two ways to interpret the data; there’s the glass half full and the glass half empty methods
- The glass half full:
Some people look at 8.3% inflation and say; this is good because last month the reading was 8.5% so, we’ve hit an inflation point with 8.5% being the highest and now we’re finally starting to come down, the worst of inflation is behind us so, this is good.
- The glass half empty:
The glass half empty approach looks at the data and says wait a minute, 8.3% is still ridiculously high, we want inflation to be anywhere between 2% to 3% on average per year not 8.3%.
In fact, when we look at the popular core inflation metric which takes out food and gas prices, the data showed 0.3% for March and 0.6% for – doubled in less than a month. So there’s actually no guarantee that we’ve seen the worst of inflation, it could still very well get worse.
Bitcoin is falling and the Fear and Greed Index is pretty much broken so if you’re new to crypto welcome to the crypto space where nothing is impossible. Personally, I believe this is one of the best times to get started and if you’re a veteran in crypto you know that the best time to buy bitcoin is when everyone is scared.
One of the reasons why crypto markets are all red this week is partially thanks to a project called Terra luna which is a stable coin project whose value was pegged to bitcoin. Terra was always supposed to be worth $1, it’s pegged one-for-one and one of the ways it keeps its dollar status is by relying on another crypto called Luna; the promise is that you should always be able to exchange $1worth of Terra for a $1 worth of Luna and vice versa so, Luna was used as a price shock absorber to keep the volatility stable for Terra at $1.
Here’s an example of how this could work; if Terra ever drops below $1, you could spend a dollar to get a dollar’s worth of Terra to convert immediately into Luna and get more than a dollar’s worth of Luna for instant profit; and the reverse is true if Terra goes above $1, you could buy a dollar’s worth of Luna and convert it into terra and get more than a dollar’s worth of Terra for instant profit.
This project used both of these currencies to keep each other stable and this system actually works as long as people have faith in the system but, if they don’t and they start to sell both, you get what’s called the Dreaded Death Spiral. This is the situation where the value of both coins goes down because each of them has a negative selling pressure on the other and they both erode each other’s values into nothingness and people stop doing this arbitrage technique because they don’t trust the system and they don’t want to lose more money.
There’s an amazing analysis by on-chain wizard which describes exactly what happened; it turns out there was an attacker and the attacker spent $350 million worth of UST to drain the liquidity pool and make people panic, that was when trades were frozen and at that point, the attacker spent another $650 million to offload all that money on Binance, with that, people really started to panic because it de-pegged the value from the dollar all the way down.
It was at that point that Bitcoin needed to be sold off to maintain the value of that dollar and to keep the system stable so, that’s partially one of the reasons Bitcoin went from $42, 000 down to $31, 000 because Bitcoin was used as collateral to keep the whole system stable.
It’s pretty crazy what ended up happening and here’s the craziest part; if the attackers covers their short position and buys Bitcoin back at $32, 000, they could profit something like $800 million dollars from this attack!
So even though Bitcoin wasn’t directly attacked it was indirectly affected because this system relied on Bitcoin to keep it functioning and that’s how this utopian dream of DeFi, which is the promise that we could run the financial system in a decentralized way, has been through series of attacks. When people’s faiths are shaken, they get scared and sell out and the value goes down so that’s exactly what happened now.
Experienced crypto investors like Wes Spencer have suggested we look at the yearly lows instead of the yearly highs for perspective, for example; in 2019 Bitcoin’s low was closer to $3, 400, in 2020 it was closer to $5, 000, and in 2021 it was $28, 000 so, 2022 could be a lot lower, who know? But even if that’s the case Bitcoin’s run has been incredible and it will continue growing at an insane pace. What has happened this week is a quick but really brutal reminder that the market won’t always be green and that’s fine because times like this which hurt, which are not fun are a necessary part in keeping the economy healthy, so use this time to master your own emotions because if you can do that, you will beat most investors with time.