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Reviews |  How Crypto Became the New Subprime

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Reviews | How Crypto Became the New Subprime

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If the stock market isn’t the economy – which it isn’t – then cryptocurrencies like Bitcoin really aren’t the economy. Still, crypto has become quite a big asset class (and has generated huge capital gains for many buyers); as of last fall, the combined market value of cryptocurrencies had reached nearly $3 trillion.

Since then, however, prices have crashed, wiping out an estimated $1.3 trillion in market capitalization. As of Thursday morning, Bitcoin’s price was almost halfway through its November peak. So who is affected by this crash, and what might it do to the economy?

Well, I see some uncomfortable parallels with the subprime mortgage crisis of the 2000s. No, crypto doesn’t threaten the financial system – the numbers aren’t big enough to do that. But there is growing evidence that the risks of crypto fall disproportionately on people who don’t know what they’re getting into and are ill-placed to handle the downsides.

What is this crypto stuff? There are many ways to make digital payments, from Apple Pay and Google Pay to Venmo. Traditional payment systems, however, rely on a third party – usually your bank – to verify that you actually own the assets you are transferring. Cryptocurrencies use complex coding to supposedly eliminate the need for these third parties.

Skeptics wonder why this is necessary and argue that crypto ends up being a clumsy and expensive way to do things you could have done more easily otherwise, which is why cryptocurrencies still have few legal applications 13 years after the introduction of Bitcoin. The answer, in my experience, tends to take the form of a salad of incomprehensible words.

Recent developments in El Salvador, which adopted Bitcoin as legal tender a few months ago, appear to bolster skeptics: Residents attempting to use the currency find themselves facing huge transaction fees. Still, the crypto has been effectively marketed: it manages to both look futuristic and appeal to old-school Goldbug fears that the government is inflating your savings, and huge past gains have lured investors worried they’re missing out. thing. Thus, crypto has become a big asset class, although no one can clearly explain what it is for.

But now the crypto has crashed. Perhaps it will recover and soar to new heights, as it has in the past. For now, however, prices are down. Who are the losers?

As I said, there are disturbing echoes of the subprime crash 15 years ago.

Crypto is unlikely to cause a global economic crisis. It’s a big world, and even $1.3 trillion in losses is only about 6% of US gross domestic product, a hit that’s an order of magnitude smaller than the effects of fall in real estate prices when the real estate bubble burst. And activities like Bitcoin mining, while environmentally destructive, are economically banal compared to the construction of houses, of which dive played a big role in causing the Great Recession.

Still, some people are hurt. Who are they?

Investors in crypto appear to be different from investors in other risky assets, like stocks, which are disproportionately made up of affluent, college-educated white people. According to a survey by research organization NORC, 44% of crypto investors are non-white and 55% do not have a college degree. This matches anecdotal evidence that crypto investing has become remarkably popular among minority groups and the working class.

NORC says it’s great, that “cryptocurrencies are opening up investment opportunities for more diverse investors.” But I remember when subprime mortgages were celebrated in a similar way – when they were hailed as a way to open up the benefits of home ownership to previously excluded groups.

It turned out, however, that many borrowers didn’t understand what they were getting into. Ned Gramlich, a Federal Reserve official who has unsuccessfully warned of growing financial dangers, asked, “Why are the riskiest loan products being sold to the least savvy borrowers? He then said, “The question answers itself.” Home ownership fell sharply after the bubble burst.

And cryptocurrencies, with their huge price swings seemingly unrelated to fundamentals, are about as risky as an asset class can get.

Now, maybe those of us who still don’t see what cryptocurrencies are for other than money laundering and tax evasion are simply missing the picture. Perhaps the rising valuation (but not usage) of Bitcoin and its rivals represents something more than a bubble, in which people buy an asset simply because other people have made money. with this asset in the past. And it’s OK for investors to bet against skeptics.

But these investors need to be both well-equipped to make that judgment and financially secure enough to withstand the losses if the skeptics turn out to be right.

Unfortunately, this is not happening. And if you ask me, regulators made the same mistake they made on subprime: they failed to protect the public from financial products no one understood, and many vulnerable families could end up pay the price.

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