Cryptocurrency investments not suitable for most people

While major investment houses like Goldman Sachs, Morgan Stanley and BlackRock invested heavily in bitcoin and other cryptocurrency assets, the biggest losers were the millions of young individual traders.

For the first time in history – outside of a widespread markets collapse – a major so-called asset class has lost more than $US1 trillion ($1.4 trillion) in three months. By Friday, the cryptocurrency market led by bitcoin had fallen more than 45 per cent since its October peak.

The total value of the cryptocurrency market was down from around $US2.6 trillion to about $US1.4 trillion – a fall of $US1.2 trillion.

New York investment houses worked well into Friday night calculating just how much more they had lost in the fall that day, which sent bitcoin down 15 per cent to around $US36,300.

While major investment houses like Goldman Sachs, Morgan Stanley and BlackRock invested heavily in bitcoin and other cryptocurrency assets, the biggest losers were the millions of young individual traders. Many were wiped out.

And often, it was the young inexperienced executives of the major institutions who convinced boards that cryptocurrencies were a new asset class.

Sudden collapses show that, currently, cryptocurrencies are in a class of their own.

In a sad piece of timing, Goldman Sachs, at the start of the 2022, predicted that bitcoin would rise about $US100,000 in the next five years. Maybe they are right, but the sentiment sucked in more small investors who were then savaged.

Morgan Stanley supported a special bitcoin investment vehicle called the Grayscale Bitcoin Trust which attracted more traditional investors. They have been horrified by its 50 per cent share price drop since November. Grayscale losses total around $US17bn.

The major investment houses need to confess their exposure.

Until they do, there will be considerable speculation and – along with the dangers in Ukraine – this may impact wider markets.

One of the beneficiaries of these frightening scenarios has been US bonds, which jumped on Friday as frightened investors sought safety.

To be fair to the cryptocurrency market, there was a similar fall last May, which slashed $US900m from the asset class. But after the May 2021 slump the major investment houses poured money into the market. That encouraged others and the cryptocurrencies recovered their lost ground.

This week will be an important test. All those involved in cryptocurrencies hope that the big investment houses will repeat May and stabilise the markets, helped by the abundant liquidity in the US.

During Friday evening and early Saturday morning, New York time, there were further falls as more unfortunate young traders were sold out.

But at least some institutions on Saturday morning knew that unless they moved in there would be more carnage on Wall Street on Monday – multiplying their losses. Suddenly buying appeared and bitcoin began to recover from its lows.

The base cryptocurrency buyers in recent years have been young people who saw bitcoin and others as a way of gaining the wealth that they believe they had been deprived of in the current asset boom. They were often politically correct, and saw their role in supporting crypto with almost religious zeal that encompassed liberty-seeking anti-authoritarianism. Some believed cryptocurrencies would eventually destroy existing financial structures.

They were also joined by the Chinese, who saw trading in bitcoin and cryptocurrencies as a way of becoming less dependent on the communist party government. Xi Jinping recognised the danger to his rule and last year greatly restricted their ability to speculate on cryptocurrency. With hindsight, Xi did them a favour. Russia also clamped down on cryptocurrency trading.

This means that this round of cryptocurrency losses is concentrated in Western countries.

Many of the young buyers had no secret agenda but were sucked in by celebrities extolling the virtues of this new asset class. Some of those celebrities appear to have received a fee.

Other buyers were attracted by the support of billionaire Tesla founder Elon Musk.

But the young people had no knowledge of history and often entered the crypto markets with highly leveraged margin deals. Their equity was geared up to 10 times. That meant that they made huge fortunes on the rise but were savaged on the fall.

The margin lenders, knowing they were dealing with young people with limited capital, sold them out as soon as the cryptocurrencies fell to the trigger levels.

This cascaded into a massive vicious circle because every fall triggered more sell-outs.

There is no doubt that the big fall on Friday was caused by massive selling of young people’s bitcoin and other cryptocurrency by their lenders. And the big traders also shorted bitcoin.

Given the size and speed of the fall, some of the lenders may have been caught with losses which will be hard to recoup.

In my view, the simple truth is that bitcoin and the cryptocurrencies can’t be a serious asset class for ordinary investors when the security is being traded on the basis of 90 per cent borrowing. That leaves the asset class open to huge falls which normal investors only expect in a global crisis.

It is true that some of the selling was created by higher bond interest rates, but the rate rise has not been substantial enough to trigger a fall of this magnitude on its own.

There is little doubt that the world is looking for digital currencies to help co-ordinate the increasing amount of digital services trading. Unless the major institutions are prepared to support bitcoin when there is a selling rush, then bitcoin is not that currency.

Twice in a year it has experienced sickening falls.

The cryptocurrency world will be on the edge of their seats on Monday to see if the investment houses are prepared to again throw money at the market to protect investments or whether the weekend buying was just short covering.