Cryptocurrency prices and Coinbase stock plunge — so what is happening?
A perfect economic storm for a possible recession on the horizon
The value of cryptocurrency and stocks have both plummeted hard in recent days. A May 12th 2022 article published by Forbes explains that over the past month, more than $1 trillion in value has been wiped from the cryptocurrency market, with Bitcoin down 12% to $27,000 between 11th-12 May 2022. The recent lows highlight an ongoing market downtrend for cryptocurrency, with Bitcoin down 61% from its all-time high of $68,000, which it reached in November 2021.
Moreover, an article also published on 12th May 2022 by the Independent states “investors say they have lost fortunes” as “crypto prices collapse”, adding that “widespread fear in the [cryptocurrency] market” has been exacerbated by the “collapse of Terra Luna”. On 11th May 2022, Terra Luna fell 99% overnight as its price crashed to under $1 from $120.
A GfinityEsports article explains that its link with compatriot stablecoin TerraUSD (UST) caused the crashes of both. The article explains that
UST is an algorithmic stablecoin and is operated via computer codes that help maintain its price equilibrium. The process involves burning or minting LUNA/UST to maintain the price of these tokens.
When a UST is minted, $1 of Luna is burned, while this also happens the other way around for Luna minting and UST burning. As UST threatens to go below its peg, holders will sell their UST (or burn it) for $1 of Luna, making a slight profit. This is until UST rises above $1, when the opposite encouragement happens.
After a large amount of UST was dumped, the stablecoin started to depeg. More UST was sold in a mass panic, minting more Luna and increasing its circulating supply. This had the knock-on effect of then crashing the price of Luna.
What happened with Terra Luna caused a ripple effect across the whole cryptocurrency market, knocking the prices of other coins down. This drop was likely caused by people selling their holdings as generalised uncertainty and increased fear about cryptocurrency’s prospects became more acute.
As another article published by the Independent explains, the “Terra crash comes amid a downturn for the broader crypto market, which has seen bitcoin fall more than 50 percent since its all-time high of close to $69,000 in November”. What has happened to cryptocurrency prices in recent days is symptomatic of a perfect storm for the economy, with its tempestuous effects felt across the stock market as well as in more peripheral cryptocurrencies.
ABC News reported on 11th May that leading cryptocurrency exchange platform Coinbase “has lost half its value in the past week”, posting a Q1 $430 million loss at -$1.98 EPS, defying analyst expectations of $0.08 EPS. Muddled paper talk of the potential impact Coinbase bankruptcy would have on its users will not quell investors’ current fear, despite Coinbase CEO Brian Armstrong stating the company has “no risk of bankruptcy”.
Coinbase stock and cryptocurrency prices have both fallen violently over the past few days. However, their prices have been in a prolonged downtrend for months, since posting all-time highs in November 2021. More broadly, many other stocks have experienced astonishing price crashes in the last couple of months, felt acutely among tech- and growth-company stocks. Notable victims of these price crashes have included Netflix, Peloton, NIO, Tesla, Meta, and Boeing, as well as plenty of less well-known names.
When prices of specific equities fall more dramatically than general market fluctuations, these changes are likely to have microeconomic causes, relevant to the composition and market prospects of that particular equity. When trends are apparent across the prices of multiple types of assets, such as in this case, downward trends have fundamental macroeconomic causes. The broad crash investors have witnessed has been caused by the aggregation of external pressures. These external pressures have contributed to microeconomic capitulations, such as that experienced by Terra Luna.
Macroeconomic pressure, microeconomic capitulation
An article published on 12th May 2022 by the Financial Times offers a quote from portfolio manager Rosie Bullard, who states that the “market’s just not interested in jam tomorrow companies any more” to describe the collapses of tech- and growth-stock prices. She adds that there’s “uncertainty both in the economic outlook and tech business models…given how much the tech industry has risen in recent years there is room for it to go down further.”
Bullard’s remarks remind of the warnings expressed over the past two decades by veteran Berkshire duo Buffett and Munger, who have both warned investors against pursuing financially unproven but technologically flashy businesses. The duo have consistently criticised the approaches of fund managers who go after young and often unprofitable businesses, justifying their investment decisions by speculating on possible future value, rather than identifying companies with solid fundamentals and fair prices to invest in. The Berkshire chiefs have repeatedly argued that speculative investing results in overinflated prices, yet have been repeatedly derided as “dinosaurs”.
A CNBC article quotes Munger’s astute views on the approaches he considers disingenuous and misguided taken by investors who focus on EBITDA, to highlight how careless he thinks many investors have become:
To make his point about excess, Munger cited the proliferation of EBITDA as a fake profit metric. “I don’t like when investment bankers talk about EBITDA, which I call bulls — earnings,” he said.
“It’s ridiculous,” Munger said, noting EBITDA — which is short for earnings before interest, taxes, depreciation and amortization — does not accurately reflect how much money a company makes, unlike traditional earnings. “Think of the basic intellectual dishonesty that comes when you start talking about adjusted EBITDA. You’re almost announcing you’re a flake.”
In their view, what has happened and is continuing to happen to the prices of many stocks and cryptocurrencies, is simply a regression closer to normal, as stock prices approach an approximation of a more accurate value.
Munger’s and Buffett’s criticism is always general, and there may be exceptions to the general principles and ideas they espouse. Nevertheless, the pair essentially believe that what has happened in cryptocurrency and stock market prices has been an inevitable unravelling, as money has simply come out of overvalued assets, causing their prices to drop.
But why have people have decided to sell off? That is the critical issue linking the macroeconomic situation with the performance of specific businesses.
The FT quotes Juliette Cohen of CPR Asset Management to explain that “growth is under pressure from declining pandemic-era fiscal support, supply chain bottlenecks and a slowdown in China driven by stringent coronavirus lockdowns”. These socioeconomic pressures have strained businesses worldwide, resulting, according to Robert Buckland of Citi, in “three key stagflation themes: higher inflation, slowing growth, and rising rates”.
Inflation has placed pressure on wage earners as the cost of living increases. The Ukraine crisis has not helped here, pushing prices of certain goods up for many consumers across the world as sanctions have curbed supply (mostly of raw materials — such as metals, crop yields, and oil & gas). As prices increase while wages stagnate, many people may be forced to sell investments off to cover this higher cost of living. This external economic pressure creates the imbalance between people rushing to sell their equities and people prepared to buy, the imbalance which is needed to cause stock prices to drop.
This has been reflected in the indexes: sustained S&P 500, FTSE 100 & 250, & NASDAQ drops in value have ushered in whispers of a recession, with analysts at Bespoke Investment Group commenting that “more often than not, when lightning fills up the sky, thunder typically follows”.
Some stocks and equities have fallen harder than others — Coinbase, Peloton, Terra Luna, and Netflix each providing salient examples of assets hit particularly hard. Fear and uncertainty about assets like these have been amplified by negative publicity, in the instances of the companies, dismal Q1 2022 earnings reports. Interest rates have recently been hiked and further increases may be on the horizon. Higher rates of interest mean people and institutions cannot afford to borrow as much.
When people’s ability to borrow low- or zero-interest funds diminishes, people are encouraged to spend more on only what they can afford. This theoretically has a significant impact on the composition of the market (and therefore stock prices), as people hypothetically cut down expense on superfluities.
These dynamics have been magnified in recent weeks as the sky has well and truly fallen for a plethora of equities. What is less clear is how far left the sky has to fall, and for how long it will remain prostrate once the dust begins to settle. For those caught up in the market madness of 2020–2021 which experienced its frenzied culmination with the absurd AMC/GME explosions that ran against all fundamentals, recent crashes may prove ruinous.
The Independent’s coverage of Terra Luna’s crash provides ample examples of this, explaining that Reddit Moderators were forced to pin “a post with helpline numbers to the top of the page after users voiced concern about the consequences of the crash” — consequences including personal bankruptcy and financial ruin, with one Luna investor explaining that he “lost over $450,000. I cannot pay the bank. I will lose my home soon. I’ll become homeless.” It is hence no underestimation to acknowledge that this crash will destroy lives and businesses. The knowledge that those with capital saved and ready to spend can benefit from the circumstances responsible for their destruction is the final, hard, merciless kick in their teeth.