Why crypto crashed, and what happens next

The crypto market took a swan dive off the high board in early May and left investors with the sting of a summer camp belly flop. A steep sell-off brought the price of bitcoin, the best known and most valuable cryptocurrency, to its lowest point since 2020. More than $300 billion in value was vaporized in an instant, and some $1 trillion in aggregate value was lost once the dust settled.

News headlines were understandably apoplectic: “Melt down,” “a perfect storm,” “like the dot-com crash,” “ turmoil and panic.” Crypto critics used the plunging prices to renew arguments that the category is digital snake oil. Supporters pointed to previous crashes as a demonstration of crypto’s short-term volatility and long-term value.

So what’s really going on? Morning Brew asked Alkesh Shah to find out. As global head of crypto and digital assets strategy at Bank of America, it’s Shah’s job to figure out what’s happening for the second largest bank in the US. Here’s what he had to say.

Most Morning Brew readers saw the cryptocurrency market plummet in early May. There’s been a lot of anxiety since—notable for an investment community that gave rise to the battle cry “HODL,” as in “hold on for dear life.” So I want to know: Do you believe this to be a correction to an inherently volatile market, or a referendum on a hype machine? What’s really happening?

In our view this is a correction. Skeptics are louder when share prices are going down. We’re hearing a lot more from that point of view right now and less from the people who are optimistic. It’s not that there’s any end to this sector.

Think about the major downturns in this space. The first one occurred [in early 2015] when bitcoin stood by itself as a proven cryptocurrency, and there was potentially some investor disillusionment early on about what they held. The second time was the ICO bubble [of 2017] and it became clear that a number of businesses weren’t fully baked.

What’s different now is what Ethereum started—a whole separate software infrastructure. Now you have a blockchain functioning as an operating system. The applications that are being built on [these platforms] are not going away. They’re real and people have true use cases for them: supply chain efficiency, FEMA claim reduction, things to power the metaverses of the future. That’s why this sector isn’t going away.

Even if investors are still licking their wounds right now. The price of bitcoin is down 44% over the last six months, to about $31,000. Peer cryptos aren’t much better.

Many of our smarter investors are using this correction to do the work to understand the space better.

The reason we think it’s a correction is, if you think about the last 18 months, the most value growth was in the software ecosystems I mentioned. The higher growth was in altcoins [those are coins not named “bitcoin”] and blockchain operating systems.

The total value of the crypto market was $780 billion in January 2021. Then it peaked at $3 trillion in November as investors began to recognize that there was a bigger opportunity than just currency. Crypto began to act like a risk asset. All risk assets went up in value last year. And then: Inflation, rising interest rates—this hit all risk assets, and this sector as well. At almost $1.5 trillion, global crypto market capitalization is still double January 2021. It went up more than 300% and now it’s down 50% from that $3 trillion.

Despite the market drop, we’re still seeing developer activity on those blockchain systems. There’s still venture investment happening. Our view is that venture financing for innovation in this space is not slowing at all.

I notice you’re being careful with the language you’re using to describe all of this: “sector,” “space.” When you say “crypto,” you’re not just talking about currencies, are you?

I’m viewing all of this as the underlying blockchain systems and the protocols. To me it’s all Web3, whereas crypto really goes back only to the blockchain. There’s a lot of misleading language in this space. There are very few cryptocurrencies used as currency.

I want to talk about those applications you mentioned. I’ve been reading a lot of crypto criticism in the wake of the latest crash. Paul Krugman in the New York Times comes to mind; in May he wrote: “Cryptocurrencies play almost no role in economic transactions other than speculation in crypto markets themselves.” Even after 13 years of existence. Is that a legitimate criticism, or a fundamental misunderstanding of what you’re optimistic about?

That criticism is about a specific application, a specific use case: “Why can’t I use this as currency?” Currency is not the killer application here. There are many [killer applications] for working on a blockchain operating system, including payments. But the one most easily seen right now is NFTs. I’m not talking about digital art entities and collectibles; I’m talking about creating royalty streams around intellectual property. When Time sold an NFT of the art of the cover they did with Beeple, they sold it for about $350,000, split evenly. But because they used new software architecture, they attached a smart contract to the cover art so when the buyer sells it at significant multiples, 10% will go back to the original owners, again split between them. That will happen in perpetuity.

Similarly, when The Chainsmokers created NFTs for their new album So Far So Good, they gave 5,000 fans a shared call option of 1% on the money the new album makes. So you’re creating something that not only engages the fan base, but also creates royalties. This can be done with book publishing or event tickets. That’s a true use case.

If you’ll allow me a brief tangent: Recording artists like Bob Dylan, Shakira, Prince, Mötley Crüe, and Bruce Springsteen have made waves over the last six months or so for selling their catalog rights for tens if not hundreds of millions of dollars to companies like Hipgnosis and Primary Wave. Should they have considered an NFT instead?

You could create an NFT of the catalog. I wouldn’t say anyone is making a mistake, but I certainly would consider an NFT.

OK, let’s get back on track. What’s another killer application of crypto?

Stablecoin. Ignoring what happened with Terra’s luna—which is not a true stablecoin because it wasn’t actually backed by any reserves, even though it was pegged to the dollar—imagine if you’re in a Facebook-type metaverse and want to conduct a transaction with another user. Why should you care if the person is in another country? If you pay them with a stablecoin, the money moves from your wallet to theirs as quickly as email. Using the traditional banking system, it could take two to five days and there could be incremental fees.

A week ago Christine Lagarde, president of the European Central Bank, said cryptocurrencies were “worth nothing” because “there is no underlying asset to act as an anchor of safety.” But you’re saying a proper stablecoin is precisely that.

There were two parts to her statement. First, she didn’t understand how any crypto asset had intrinsic value. And second, she’s asking, how do you know what the reserves are? We believe there need to be regulatory frameworks requiring a company that issues a stablecoin show audited reserves to prove the token can be redeemed for, say, a dollar. That doesn’t exist today; it’s all voluntary. That [evolution] would be great. And based on statements by public officials around the world, that’s very likely by year-end.

As for the second part, she was more likely talking about bitcoin. But ethereum had [billions of dollars worth] of transaction fees last year. You actually have a form of cash flow. That’s how you derive value—forecast future cash flows, discount it back, create intrinsic value. There is a valuation framework that hasn’t been created yet but could be, showing true value for these blockchain operating systems, subsequently prompting public policy leaders to change their views on these assets.

Web3 is so interesting because you actually own a piece of the platform. It’s not a license.

If you’ll forgive a sports analogy, it’s like the ownership structure of the Green Bay Packers football team—unlike other NFL teams, it’s owned by hundreds of thousands of fans.

Exactly. That’s what Web3 is all about.

This interview has been edited and condensed for clarity.