This isn’t my First Rodeo – A Corner of Crypto Implodes

This isn’t my First Rodeo – A Corner of Crypto Implodes

This isn’t my First Rodeo – A Corner of Crypto Implodes

“I can’t take it anymore”

“I can’t take it anymore”

“I can’t take it anymore”

A 29 year old was sitting across from me, despairing after having lost two thirds of his life savings speculating in crypto. Most of the losses came on the day of the Luna / Terra stablecoin implosion. As the stablecoin was falling, greed took over and he used most of his savings to average down his existing holding, betting on a rebound. Instead it went to zero.

The Luna / Terra debacle has already been dissected at length. Terra was a stablecoin that maintained a peg to the US dollar by virtue of the relationship to Luna and an algorithm that tied the two together.  One would think that such a circular logic construct could never seize the minds of speculators, but against the odds it became a $40 billion crypto behemoth.  Such a construct can only survive as long as the users believe it will survive, and on that fateful day belief was suspended as some large holders started selling.  

Crypto is no longer a fringe invention, having become large enough that it is ensnaring plenty of young naïve investors.  While crypto claims to democratise and decentralise money, in reality this wealth is concentrated in very few hands.  For the vast majority of speculators it is becoming a destructive force, and they are unknowingly participating in a big financial experiment that will leave many more casualties in its path to either widespread acceptance or total failure. 

We should all have seen the Terra/Luna collapse coming from miles away. Some called this a black swan. They should reread the definition of a black swan. The only way you get surprised by such an event is if your head is stuck so far in the crypto universe that you become blind to the risks. The number of people who saw this coming are legion. I wrote about the fragility of stablecoins a year ago when another similar event occurred. In July 2021 the stablecoin Iron Titanium blew up in the early morning hours, after climbing more than 10x in a short period, much like Terra did. The stablecoin graveyard will get larger, we haven’t seen the last of it. 

Here is where old-timers like me, who don’t fully see the purpose of crypto but are trying to keep an open mind about its potential, can offer some lessons to young speculators.  The post-mortem articles on Terra/Luna did a good job of describing the blow-up after the fact, but as I sat across the young man and gazed into his look of hopelessness I wondered about how many more had lost their life savings. It was time to take a deeper dive into the risks of crypto, as there are many similarities to traditional finance, in order to save investors from losing their life savings.  

Lesson one: there is no objective measurable value (like present value of future cashflows) underpinning any of these prices (at least not yet, but maybe not ever). Without such an underpinning, prices can go anywhere. When a stablecoin loses its peg don’t bottom fish. It is far more likely to go to zero. 

A month before the Terra debacle, I was having dinner with famed hedge fund manager Jim Rogers, and the topic turned to the abundant speculation in crypto. I explained my short thesis on another stablecoin, Tether. Jim, being a septuagenarian investor, professed to not understanding all the nuances of crypto, but as I explained the lack of audits in Tether’s books and the questionable history of its founders, his conclusion was clear: “This isn’t my first rodeo. I know how this ends.’

It's fascinating that crypto proponents use their moral objection to money-printing by central banks as justification for a monetary system that is decentralised, outside the control of banks and governments. And yet they say nothing when billions evaporate in a single day from failed crypto projects. Worse still in these events the majority of speculators are lured in after 10x gains have happened, hoping for another easy 10x upside.  Terra’s failure caused over US$40 billion of circulating crypto supply to evaporate. It’s unprecedented that something this large failed, but there’ll be even larger crypto failures in the future.  

Worst of all, it looks like a handful of wallets that seem to belong to professional crypto investors were able to get out early. Most retail investors instead held all the way to zero.

In a world where a crypto protocol can go to zero in a matter of minutes, this is a game best left to professionals. Just like in futures trading, I can already tell any young person that comes to me with a profitable trading strategy that they will blow up their account. It’s not a matter of if, but when. These personal blow-ups are essential scars on the way to becoming a successful investor, and I tell them to come back after they’ve blown up, with their lessons learned and their trading strategy refined.

I counselled young speculator sitting opposite me that he has two choices, he can continue to despair at his misfortune, or realise that bad luck had nothing to do with it. The culprit was his bad decisions and lack of proper research.  I told him about my first experience in trading. I was 13 years old, and wanted pocket money from my father, as all my classmates had. He said no. Instead, he wanted to teach me a lesson. He set up a small brokerage account in his name and said I should learn about investing in the stock market, giving me the reins. The terms were that I could take out gains, but not the capital. This was six months before the infamous Black Monday. I doubled the capital in the portfolio in just a few months, and thought I was a genius, marvelling at how easy this way. The gods were to teach me a lesson, it only took two days for the account to go to zero after a margin call. 

I agonised for days on how I would tell my father the bad news, getting little sleep each night.  My father watched with amusement, he already knew that this would be the outcome. When I finally plucked up the courage to tell him, he said: ‘Don’t ever forget this lesson. It’s good that you learn it with 10 thousand instead of 10 million.’

Lesson two: do thorough research before putting money at risk. Anything else is gambling with worse odds than the casino. Investors with more than a few decades of experience have seen many of these speculative periods play out before. It’s not our first rodeo. As Jim will tell anyone who will listen, the participants and the settings are different, but the end result is the same.  

Lesson three: beware of leverage. Before the onset of decentralised finance (DeFi), you put fiat money into crypto and could simply hold on. The introduction of DeFi has been hailed as a game-changer. It’s true, but it’s a game changer in many negative ways too. The creation of ‘interest’ and being able to lend out your crypto coins introduces leverage to the system. High interest rates of 20% up to 100% lure in speculators who do not understand the risks. Introducing leverage to any financial system introduces the risk of margin calls, amplifying crypto’s already enormous volatility. Adding leverage to a financial system will always have the same result: corners of the system will blow up over and over again. If the system is unregulated, the downside risk is even larger. So far DeFi’s landscape is littered with stablecoin blow-ups. Instead of achieving a utopian financial ecosystem, it has caused massive destruction in wealth. There is a reason why the traditional banking system is highly regulated.

More than a decade since bitcoin’s invention, we still haven’t seen a practical application that has entered the mainstream. What is the problem that bitcoin and other crypto currencies are trying to solve that can’t be done better elsewhere? The system remains clunky for payments. Transfers are slow and expensive. I made an experiment with a friend to transfer Ethereum from a bank to each other and back to the banking system. The exchange fees and ‘gas’ fees were enormous, and it turned out that the fees during our test were particularly high because the Bored Ape Yacht Club real estate land grab was going on at a similar time, an event that temporarily crashed the Ethereum blockchain. 

So here we have a money transfer system that gets slower and more expensive the more it is used. How can this possibly replace our existing ways of transferring money? Can crypto still be called a currency? The exchanges, miners, and other entities in the middle of all these transfers are the ones that are minting money, at the expense of the speculators.

Crypto is clearly also not an inflation hedge. Instead it is behaving like a speculative vehicle that is highly correlated to technology stocks.  So what do we have left? Is it a store of value?  Ever since entering the crypto rabbit hole, I’ve been trying to figure out what the purpose of all this is. So far the reasoning by crypto enthusiasts has been vague, talking about the benefits of a decentralised money transfer system and how the old gold standard of sound money is much better than the incessant money printing by central banks. 

Instead it is increasingly looking like the real applications are around blockchain technology in ways which have nothing to do with money transfers and payments. Getting exposure via blockchain venture and private equity may be better than gambling on the latest coin issuance.

I’ll end this article with an interesting perspective on the ‘wealth’ created by crypto, by Victor Haghani of Elm Partners. It goes a long way to explain the ‘value’ of the crypto-currency space.

Hassan and Ali are antique dealers in the bazaar. Hassan notices a beautiful antique bowl in Ali’s shop, which Ali was given by an itinerant dervish in return for a cup of rice. Hassan asks Ali for a price to buy it, but Ali doesn’t want to part with it completely, so offers to sell Hassan a three-quarter share for 75 Rials. The next day, Ali drops by for tea and expresses regret at having sold a majority interest in the bowl. Ali proposes buying back half his previous sale, but Hassan is reluctant. Now Ali has to offer 75 Rials for a three-eighth share to get the deal done. The next day Hassan is having some fear of missing out (FOMO), so he wants to buy back a three-sixteenth interest in the bowl, and again it takes 75 Rials to get Ali to the table.

After 30 days of this very sociable pattern of trading, Ali and Hassan congratulate each other on discovering such a valuable business. Based on their last trade, in which Ali bought back a roughly 1.5 billionth interest in the bowl for 75 Rials, they valued the bowl at about 50 billion rials, with ownership split almost exactly 50/50, and their bank accounts exactly as they were before the very first trade.

They spend the evening drinking to their success, hatching plans to sell a small interest in the bowl to passing tourists, or posting the bowl as collateral for a large loan that will give them a chance to enjoy their new-found riches. But that very night, the bowl was stolen. Down on his luck, the thief exchanges it for a bowl of rice in the bazaar of a distant city.

What was the bowl worth?

Were Hassan and Ali the victims of a colossal theft which robbed them of 99.99% of their wealth? Looking at the price at which they last traded a miniscule fraction of the bowl, the answer would seem to be “yes,” in line with the modern market convention of computing value by taking the last marginal trade price and multiplying by the number of shares. But we suggest a more sensible way to think about the wealth generated by an asset is as the present value of the future consumption it can support. Hassan and Ali may have been able to sell a few fractional shares to unsuspecting tourists, or hoodwink a hapless loan officer into giving them a small loan against the bowl. But it’s clear there’s no way this bowl could support 50 billion rials of future consumption, or anywhere close to it. The true wealth stolen from them was a lot closer to one cup of rice.

Final lesson four: Know the value of what you’re investing into, and the difference between value and price. When price is determined by artificial supply constraints, it can collapse to zero in an instant.

Old hands who have been at this game for many decades and survived have seen many bubbles, and can apply this experience to spot the future ones. My message to all the young people that are heavily invested in crypto who see this as the easiest way to quickly become a millionaire is to beware of the lure of easy money. Given the complexity in how the sector is evolving, non-professionals are far more likely to suffer large losses than make large profits. Instead remember that the best investment you can make at this stage in your life is in yourself, gaining knowledge and life skills so that you create value for yourself, your employer, and your community, and not squander your life savings on speculations.


Co-founder of AL Wealth Partners, an independent Singapore-based company providing investment and fund management services to endowments and family offices, and wealth-advisory services to accredited individual investors.