Crypto Crash

Context/Description: The cryptocurrency market exploded following COVID-19 fiscal stimulus and Federal Reserve money printing. Bitcoin and altcoins surged in 2020-2021. The total crypto market capitalization reached $3 trillion in November 2021. NFTs (non-fungible tokens) sold for millions. DeFi (decentralized finance) platforms offered extraordinary yields (10-20%+ on stablecoins). Centralized exchanges like FTX grew massive. Retail and institutional adoption increased. Celebrities endorsed projects. Crypto was touted as inflation hedge, portfolio diversification, and the future of finance.

Warning Signs:

• Unsustainable yields: 20%+ returns on stablecoins (where does this money come from?)
• Excessive leverage throughout the ecosystem
• Tether (largest stablecoin) questions about reserves
• Algorithmic stablecoins with questionable mechanics (Terra/Luna's circular design)
• Centralized platforms acting like unregulated banks
• Retail FOMO ("fear of missing out") mania
• Celebrity endorsements (often paid, undisclosed)
• Venture capital overinvestment in crypto startups
• Federal Reserve beginning to raise interest rates (tightening liquidity)
• Bitcoin correlating with tech stocks, not acting as independent asset

The Problem: The crypto ecosystem was overleveraged, with many platforms and funds borrowing against crypto collateral to chase higher returns. "Stablecoins" weren't truly stable—they depended on confidence and reserves. Algorithmic stablecoins like Terra's UST were especially fragile, using a circular mechanism where the stablecoin and its sister token LUNA supported each other's value. Centralized exchanges operated without proper reserves, audits, or regulation. When liquidity tightened (Fed rate hikes), the house of cards became visible.

The Trigger: In May 2022, Terra's UST stablecoin "de-pegged" from $1. The algorithmic mechanism failed under selling pressure. As UST fell, LUNA (its backing token) hyperinflated from millions to trillions of tokens. The ecosystem collapsed in days.

The Cascade:

• Terra/Luna collapse: $40 billion in value destroyed in May 2022
• Three Arrows Capital (3AC): Major crypto hedge fund failed in June 2022 due to Terra exposure and overleveraging; owed $3.5 billion to creditors
• Celsius Network: Crypto lending platform froze withdrawals in June, filed for bankruptcy in July; $20 billion in user assets frozen
• Voyager Digital: Bankruptcy in July 2022 after 3AC default
• FTX collapse: November 2022—revelations that FTX used customer deposits to fund Alameda Research (sister company) trading and loans; $8 billion customer funds missing; Sam Bankman-Fried arrested, tried, and convicted of fraud
• BlockFi, Genesis, other lenders: Bankruptcies cascaded through interconnected lending
• Contagion hit even unrelated projects as confidence evaporated

Results/Impacts:

• Crypto market cap fell from $3 trillion (Nov 2021) to approximately $800 billion (Nov 2022)—73% decline
• Bitcoin fell from $69,000 peak to $15,500—78% decline
• Ethereum fell similarly
• Billions in customer funds lost or frozen
• Thousands of smaller cryptocurrencies became worthless
• Job losses across crypto industry
• Venture capital funding dried up
• Retail investors, especially unsophisticated ones, suffered massive losses

Regulatory Response:

• SEC enforcement actions increased dramatically
• FTX collapse prompted calls for crypto regulation
• European Union passed MiCA (Markets in Crypto-Assets) regulation
• U.S. regulatory debate intensified but remained politically divided
• Criminal prosecutions: SBF sentenced to 25 years; others charged
• Increased scrutiny of stablecoins and exchanges

Recovery and Current State (2023-Present):

• Partial recovery in 2023-2024 as market stabilized
• Bitcoin ETFs approved by SEC in January 2024, bringing institutional legitimacy
• Industry consolidation: weaker players eliminated
• Focus shifted to regulated, compliant operations
• Ongoing debates about crypto's role in finance

The Lesson: High returns usually mean high risk—20% yields aren't sustainable. "Decentralized" finance often has centralized points of failure. Algorithmic stablecoins are fragile and unproven. Regulation exists for reasons—protecting customers, ensuring reserves, preventing fraud. Leverage amplifies crashes. Trust but verify—especially in emerging, unregulated markets. History repeats: Every bubble has new technology or theory claiming "this time is different."