For example, silver thursday in 1980 spilled volatility from the silver market into equity, and we saw the same thing in the subprime crisis in 2007 and 2008.. So in this video were going to look at the reasons behind the crypto sell off, but also what contagion mechanisms there could be for it to spill volatility into other markets. So lets look at the crypto crash contagion in a bit more detail. So how big is the falling cryptocurrency bean? Well, here beside me, you can see the total market capitalization of the 20 largest cryptocurrencies added up over time, and you can see it peaked at just under 3 trillion in 2021, and that was towards the end of the year. However, since then, over a period of about 220 days, its lost about 1.7 trillion of that value so, in other words its lost about 70 percent of its market capitalization. And if we look at individual cryptocurrencies, which you can see beside me here, we can see the peak to troll full in some of the largest cryptocurrencies. So the two largest of bitcoin, which peaked in november of 2021 and which is down now by about 70 percent and the second biggest, is ethereum which peaked on the same day and thats down by even more almost 80. As i make this video and then for some of the smaller cryptocurrencies such as solana and dogecoin, you can see that those are down by almost 90 or even more now.

Why did this happen? I think a lot of the reasons are the same as the reasons for the equity market sell off, which ive done in a previous video and the most important of those reasons is whats happening to inflation and also to interest rates and economic growth. In this top panel, you can see the value of bitcoin when its expressed in u.s dollars and also ethereum. Those are the two largest cryptocurrencies where bitcoin is in red and ethereum is in blue, and the two coins have followed a very similar trajectory and the panels beneath me here are three macroeconomic variables which are very relevant to the sell off the first one, of course, Is inflation in the united states and ive marked the point at which it really began to take off in march of 2021 in this first panel? Now, at that point, it didnt really trigger a huge sell off in either bitcoin or ethereum. However, you can see the rate of growth of those two certainly seem to take a dent when inflation did spike, but then things seemed to recover, particularly for ethereum, whereas for bitcoin it started to sell off and pretty much moves sideways until the next shock and thats. The dashed orange line, which you can see here and thats, probably due to this panel, which is one year interest rates in the united states. Now the federal reserve didnt start to raise interest rates until 2022, but in 2021 the one year, interest rate started to increase rapidly in expectation that the fed was going to raise interest rates and the point at which it really started to accelerate.

Is this dashed orange line notice how that occurs? Just before we saw the turning point for ethereum and also for bitcoin, so that was in november of 2021, and really neither of the two cryptocurrencies has recovered, since that acceleration in interest rates really took off. Then, when the fed actually did do its first hike in 2022 in march again, there wasnt an immediate reaction. Perhaps there was a small one, but then gradually, as the policy rate has ground higher, you can see that that hasnt been great news for either of those cryptocurrencies or any of the others for that matter. So this new regime, in which we have higher interest rates, higher inflation and also higher policy rates from the federal reserve and quantitative tightening as it shrinks its balance sheet, is an environment which seems to be toxic for some risk assets, particularly spectec speculative technology companies, which Are profitless and also cryptocurrencies, and here you can see the nasdaq index, actually the tracker qqq and alongside it the value of bitcoin, both scaled to 100 in october of 2021, that was just before risky assets peaked in 2021. notice, how the two pretty much track each Other on the way down, the only difference being one of degree, bitcoin has sold off more than the nasdaq, but of course it also rallied more than the nasdaq. Now some people have said that its all jerome powells fault. I think thats a little bit disingenuous.

I think that its certainly true that more restrictive monetary policy is not good for risky assets, but the federal reserve has to raise interest rates, its got to get inflation under control, and it has to shrink its balance sheet from its 9 trillion dollars. Currently, now that isnt a good look for things like cryptocurrency spec tech, but that really isnt a concern of the feds. Its focus is going to be keeping inflation under control and some of the collateral damage when it does that will be slower gdp growth and, of course, the collapse of these speculative assets. Now some people have done very well out of the rapid growth of cryptocurrency or you could reframe that as where are the clients yachts, hedge fund manager, jim chanels was recently interviewed on bloombergs, odd lots, podcast and his sentiment, which i agree with completely, is that one Of the problems with cryptocurrency is that theres a whole ecosystem which has sprung up overnight to feed off retail investors and charge them very high fees. And the stunning statistic which he came up with was that retail investors thats like you and i are being charged about 60 times as much as what institutional investors are charged now in any other market. That would be considered. Price gouging and thered be people up in arms about it, but for some reason in cryptocurrency, perhaps because the returns were so high, people just seemed to ignore those huge fees, but now that the cryptocurrency markets have pretty much collapsed suddenly i think therell be more focus On keeping fees low, just as there is for traditional finance now cryptocurrency platforms can extract fees in many ways.

One is an obvious trading fee, but another way to extract fees effectively is by lending money to your clients so that they can have leverage for their trades. For example, this piece of text is taken from the kraken platform and it talks about how you can borrow money from kraken in order to boost the returns on your trades. Now, of course, leverage can be toxic. It can amplify your gains as well as your losses, but thats, not the platforms problem thats our problem. However, they can profit even if we dont by lending us this margin. Now. What they actually say on their website is that the rollover fees for margin are very low and they quote a figure of 0.02 every four hours which, on the face of it, seems pretty low. Now, maybe you dont use margin in your account 365 days a year, but if you did, what would it mean in terms of compounding so zero? Two percent per four hours sounds fairly innocuous. If we convert that into one day still, it seems pretty cheap point. One. Two percent, however, if we convert it to an annual rate, suddenly it becomes really high now its 55 per year. So in fact, this is a very cost effective way for platforms like kraken, but also other platforms to make extra money. Theyre lending you money at very high interest rates, so all id say, is keep an eye on those fees. Try to find them, even if they do seem to be hidden, and do you really need margin once youve got an asset which has very high volatility anyway.

Id argue that you dont, if youve been burnt in the speculative tech wreck, but also in cryptocurrency, then why not consider learning more about risk management and diversification of your portfolio? You can do that as part of our online community, which is now managed on our website. Pensioncraft.Com, you also get access to lots of members, only videos, plus our slack channel, where we also have a cryptocurrency channel. If you want to learn more about that, just click on the link beside me or in the description beneath me now, given all that easily available margin, one of the structural problems with many cryptocurrencies has been too much leverage and the reason why thats a problem is That lets say that something triggers a market full. It could be anything, but if say, you have three times leverage. If the market falls by 10, your portfolio and your investments will fall by 30. Now, for some people, thatll just be unacceptable, maybe theyll panic and at that point, theyll close out their positions or perhaps theyll get a margin, call which they cant meet and their position will be liquidated for whatever reason people might be forced to pull out money. Now, in traditional finance, if thats a fund, then the fund itself will be forced to sell it assets and later on, well see how this analogy carries over into the cryptocurrency markets. But if there are false sellers due to margin calls and people simply wanting to cut their risk, then you get this feedback loop, such that people are selling, as markets fall, theres more leverage which has to be unwound and eventually markets enter this kind of death spiral.

Another structural problem is due to a liquidity mismatch. So as before weve got this problem with initial asset price falls, then the fund price falls due to leverage. Then weve got the problem with liquidation. People are pulling out their money, but then perhaps the fund cant sell assets. So traditionally this would have been when you have a fund which contains illiquid assets such as real estate or maybe high yield corporate bonds. People are pulling out their money. The fund cant sell assets quickly enough, so the only solution from the point of view of the fund manager is to halt redemptions. In other words, the fund is gated. Now this usually makes people very angry justifiably because they can see the value of their assets falling. Very rapidly in value, but they cant pull out their money. So this is a direct result of being able to pull out your money quickly, but the fund manager and the assets it owns are not things that can be sold quickly in a crisis. Hence the word liquidity mismatch, so the liquidity of the assets is much lower than the liquidity of the fund and thats. What leads to gating now that we understand the problems with leverage, but also liquidity, mismatches lets look at the casualties from this crypto sell off. So far, i think the first big casualty was terra, which was an algorithmic stablecoin. The idea with a stablecoin is that, instead of being very volatile like bitcoin and ethereum, instead, its value is pegged directly to the value of the dollar, so that for a long period of time here, you can see that the value of terror did keep to its One dollar peg very closely, but then on may the ninth the peg broke and very rapidly the value of terror fell very dramatically and now its worth almost zero.

Now in our podcast, many happy returns. My co host michael pew and i went into this example in quite a bit of detail, so i wont dwell on it here, but if you do want to learn more about that crisis, then why not listen to that podcast episode. Now, personally, i dodged this bullet because celsius didnt, let me open an account with them, for which im grateful, but theyve actually announced that theyve gated their platform now celsius, if youre not familiar with it, gives you a way of generating yield with your cryptocurrency, so they Take your cryptocurrency, which you hold with them and they stake it in order to generate a yield, and that can be very high, so in excess of 10, in some cases, sometimes up to 20. So it was a massive shock, as this was seen as one of the kind of safer platforms in order to do that yield farming. Now the nice thing about blockchains is that they are completely transparent and there are some really great detective work done by mike burgersburg. At least thats his twitter handle and also yield chad. So those are the two accounts on twitter, where they actually looked at the ethereum positions of celsiuss platform and they actually broke down the holdings into percentages. Now. What was worrying about this was that a lot of the holdings were very illiquid and if you cast your mind back thats a problem, if youve got a platform where people need to pull out their money quickly, because if its held in a liquid assets that can Cause a problem because of the liquidity mismatch.

Now the illiquidity in this case came from the amount of ethereum which was staked in the form of steath or alternatively, staked in the form of ethereum 2, which has still not fully been rolled out. And that meant that these two investments would be inaccessible for at least a year. You can immediately see the problem and mike bergersberg says that celsius may already be technically insolvent. Now, in theory, the steaf which was held by celsius was convertible one for one. There was a peg with ethereum, but then there was a very large sale of steep by what some people call a whale, a very large trader, and that happened on may, the 9th and after that trade. You can see that the peg between steath and ethereum broke and suddenly the holdings of celsius looked at risk, because if it couldnt convert its steath back into ethereum on a one for one basis, then it might have difficulty paying back clients money if they pulled out Of the celsius platform, so what we have in this case is a classic liquidity mismatch. The ethereum which they borrowed from users, was then staked in a form which was illiquid and might not be able to be withdrawn for a year so that if investors did start pulling out their money due to a lack of confidence, then celsius simply couldnt sell assets Quickly enough to give them their money back and, of course, the consequence was that they had to gate celsius heres.

The apology that was posted on the celsius website and the platform says that the news is difficult, but we believe that our decision to pause withdrawals is the most responsible action we can take to protect our community. Perhaps a more responsible action would have been not to stake in the form of something which is illiquid, but still the situation we find ourselves in now is that celsius has been gated for about a week, as i make this video and it still hasnt removed that Lock in then on june, the 17th another staking platform. Babel finance also announced that it was effectively gating its platform and they come up with some really great terminology which i havent heard before, which is conductive risk events thats what theyve suffered. I think that just means old fashioned contagion, but they say that theyre also facing unusual liquidity pressures, perhaps because their holdings are also illiquid now, as i make this, video redemptions and withdrawals from babel finance products are still suspended. In conclusion, then, the spillover into traditional finance, at least for now remains limited and thats. A relief to many people, all of the collateral damage so far seems to be inside the cryptocurrency ecosystem. If there was going to be contagion, it would probably come from funds which held a combination of cryptocurrency alongside their more traditional investments and that way, if they had got illiquid investments in cryptocurrency and they had margin calls or potentially had redemptions, then theyd be forced to Sell their liquid assets, which would be their equity and their bonds, so that kind of cross asset fund would be the gateway from one asset class to another.

But as far as i can see, there isnt a large fund which is in that category. The second point, which is critical for us as investors, is that risk management is really important in a bull market. If you use leverage it feels as if youre untouchable, and you feel like a genius. However, when markets turn south, which they inevitably do, particularly after a huge risk rally, then leverage can suddenly wipe out your gains and then eventually, if you had margin, it could even wipe you out completely. So many people are now learning their lesson, which is that risk management is important and you can get that via diversification, but also not getting leverage which most people simply dont need. Another point is that trading is not the same as investing investing always starts off with a long term. Mindset where you just have reasonable returns for a very long period of time. Trading, on the other hand, tries to shoot out the lights with huge 10 times 20 times 100 times returns and thats simply not sustainable, and if you do get that kind of return, you must be taking a very high risk and then you could eventually be wiped Out and most people simply dont need that level of risk, so investing is what works long term for most people and thats. Why we talk about it on our channel and, finally, a word of warning. I think, which is that this regime is just starting quantitative.

Tightening has literally just begun the feds interest rate increases have also just begun. So i think this is going to be around for a while and its going to be difficult for cryptocurrency, but also unprofitable companies to prosper in that kind of environment. So if you are buying the dip, i just say temper it with the understanding that this might be a new regime and it might be around for a long period of time. So the good news, at least for now, is that these problems do remain encapsulated to a few cryptocurrency platforms, but i think thats, cold comfort to people whove got a large amount of cryptocurrency exposure. But if something good does come out of this itll be that all of us have a stricter discipline when it comes to risk management, but also keeping our fees low and also diversifying as much as possible. Those are universal rules to all investors. Now dont forget our offer. If you want to learn about cryptocurrency, we have cryptocurrency investors as part of our community and theres a slack channel all about it and dont forget our offer. You can go to pensioncraft.com to learn more about joining our community and therell.

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