Investors hoping to make a killing as cryptocurrencies rebounded from this year’s plunge in valuations got a rude surprise last week after one of the most trusted exchanges for crypto trading, FTX, filed for bankruptcy.
But while old-school financial advisers may be tut-tutting at young and inexperienced crypto investors who they say should have known better, there are new signs a decline in speculative investments may be part of a trend that goes far beyond bitcoin and its many imitators.
Suddenly things like house prices, tech company valuations and fintech innovations, including cryptocurrency, that so recently seemed to be shooting for the moon are coming back down to Earth.
Get rich slow
Although many people are getting their fingers burned as soaring speculative investments slump, there are those who say the trend will benefit the economy.
Instead of encouraging get-rich-quick speculation, rising interest rates mean a return to the old-fashioned kind of investments that use money and workers more efficiently to create real economic value.
Some experts say that the most recent bitcoin decline does not mean that the financial innovation of cryptocurrencies has come to a dead end. Nor is housing or the new technology implicit in social media companies such as Twitter or Meta’s metaverse innately bad or useless.
But as interest rates rise and money gets tight, suddenly what seemed like an investment that couldn’t lose has been exposed as one where the business model simply does not justify that optimism.
Are they wearing bathing suits? According to a business analogy from multibillionaire investor Warren Buffett, you only know for sure when the tide goes out. (Reuters)
“A rising tide lifts all boats,” goes a familiar business aphorism. But Warren Buffett, a longtime advocate of slow growth, has added another that has become almost as famous: “Only when the tide goes out do you know who’s been swimming naked.”
But as central bankers raise interest rates, it is not just reckless speculators and mismanaged businesses that are suffering, said Lisa Forbes, a manager at SEED Winnipeg, a non-profit that teaches business skills and helps to find small loans for new entrepreneurs.
Fear of borrowing
“I’m working with people who [have what] you probably call … micro businesses,” said Forbes, whose clients often run single-person businesses such as cleaning contracts, small catering services or e-commerce retail.
Forbes grew up in Winnipeg, but her family comes from Peguis First Nation — about 100 kilometres north of the city — and many of her clients have indigenous backgrounds. She said rising interest rates are already hurting.
Lisa Forbes, who works with Winnipeg micro-businesses, says rising interest rates are scaring potential small entrepreneurs, discouraging them from taking risks. (SEED Winnipeg)
More and more, small self-financing entrepreneurs are reluctant to leave safe jobs and throw themselves into riskier ventures.
“The incredibly fast increase in interest rates is making it so that we’ve got people that are shy about wanting to get a loan,” Forbes said, adding that can mean their business never starts or is under-capitalized and ultimately unsuccessful.
While much bigger, Software as a Service (SaaS) startups and their venture capital backers — the backbone of recent tech business growth — are also retreating from risk, with reports of North America-wide business failures.
“The fact is that the glut of capital in the past few years has resulted in too many companies in every market,” Nick Mehta, CEO of the software company Gainsight, wrote in Inc.com earlier this year.
Cheap and available money can be a godsend to new entrepreneurs, but Mark Kamstra, professor of finance at Toronto’s Schulich School of Business at York University, is one of those who has worried that the cost of borrowing had recently become too low.
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“This is a feature of low interest rates that’s really very troubling,” Kamstra said after teaching a class last week. “You’ve got people who’ve an incentive to look for investments that pay very little because you can make money on a one per cent return.”
The extension of that kind of thinking can lead to individuals or businesses borrowing huge amounts of money, called “leverage,” for investments that make no money at all in the hope of eventual profits. Higher interest rates, Kamstra said, mean that collectively, we invest our resources more wisely.
He said this same kind of thinking can apply to real estate, where the arithmetic changes as interest rates go up.
“I have friends with $3-million homes, and I say, ‘You are implicitly saying that living there is worth $200,000 a year,'” said Kamstra, who rents. “If I had $100,00, I could rent a palace.”
In a world with scarce resources, he said, it may be a waste to pour money into tech startups or retail businesses or granite countertops that produce low yields, when instead you could put your money into a more difficult high-yield business such as mining and processing lithium that the world desperately needs to fight climate change.
A new dot-com bubble?
As Bank of Canada governor Tiff Macklem discussed last week, one of those scarce resources is human capital, and Kamstra worries many of his students are going into low-yield technology businesses because they offer stock options and pay well now but might not last. “What if that’s all just kind of a bubble?”
When it comes to cryptocurrency, Kamstra said he was skeptical when prices rose to last year’s highs, but he says that doesn’t rule out their future use as an innovation to reduce the high cost of finance.
But it’s not just older, traditional financial experts who are convinced that cheap capital and speculative fever got out of hand in the rush to cryptocurrency.
Larisa Yarovaya, who researches cryptocurrencies and market contagion at the University of Southampton in England, worries that the gamification of online trading platforms may have lured inexperienced investors into excessive risk-taking. (University of Southampton)
“The bitcoin bubble, and the overall hype around cryptocurrency and blockchain technology, can be compared to the dot-com bubble,” Larisa Yarovaya, who researches financial technology and market contagion at Britain’s University of Southampton, said in an email interview.
It is no surprise to her that reports of the bankruptcy of crypto platform FTX is causing contagion.
Yarovaya said the gamification of online trading platforms made investing look easy and fun, but as crypto assets shot higher and low rates made returns on other investments seem measly, inexperienced investors were captured by high-risk “crypto-exuberance” that was really gambling, not investing.
Large and institutional investors may well be directed by rising interest rates to abandon speculation in favour of searching out higher yields and long-term returns, but Yarovaya believes those who participated in the crypto and meme stock booms may be unconvinced.
Maybe the slogan “get rich slow” just won’t be as tantalizing to novice investors.
TORONTO – Canada’s main stock index was down more than 200 points in late-morning trading, weighed down by losses in the technology, base metal and energy sectors, while U.S. stock markets also fell.
The S&P/TSX composite index was down 239.24 points at 22,749.04.
In New York, the Dow Jones industrial average was down 312.36 points at 40,443.39. The S&P 500 index was down 80.94 points at 5,422.47, while the Nasdaq composite was down 380.17 points at 16,747.49.
The Canadian dollar traded for 73.80 cents US compared with 74.00 cents US on Thursday.
The October crude oil contract was down US$1.07 at US$68.08 per barrel and the October natural gas contract was up less than a penny at US$2.26 per mmBTU.
The December gold contract was down US$2.10 at US$2,541.00 an ounce and the December copper contract was down four cents at US$4.10 a pound.
This report by The Canadian Press was first published Sept. 6, 2024.
TORONTO – Canada’s main stock index was up more than 150 points in late-morning trading, helped by strength in technology, financial and energy stocks, while U.S. stock markets also pushed higher.
The S&P/TSX composite index was up 171.41 points at 23,298.39.
In New York, the Dow Jones industrial average was up 278.37 points at 41,369.79. The S&P 500 index was up 38.17 points at 5,630.35, while the Nasdaq composite was up 177.15 points at 17,733.18.
The Canadian dollar traded for 74.19 cents US compared with 74.23 cents US on Wednesday.
The October crude oil contract was up US$1.75 at US$76.27 per barrel and the October natural gas contract was up less than a penny at US$2.10 per mmBTU.
The December gold contract was up US$18.70 at US$2,556.50 an ounce and the December copper contract was down less than a penny at US$4.22 a pound.
This report by The Canadian Press was first published Aug. 29, 2024.
The crypto market has recently experienced a significant downturn, mirroring broader risk asset sell-offs. Over the past week, Bitcoin’s price dropped by 24%, reaching $53,000, while Ethereum plummeted nearly a third to $2,340. Major altcoins also suffered, with Cardano down 27.7%, Solana 36.2%, Dogecoin 34.6%, XRP 23.1%, Shiba Inu 30.1%, and BNB 25.7%.
The severe downturn in the crypto market appears to be part of a broader flight to safety, triggered by disappointing economic data. A worse-than-expected unemployment report on Friday marked the beginning of a technical recession, as defined by the Sahm Rule. This rule identifies a recession when the three-month average unemployment rate rises by at least half a percentage point from its lowest point in the past year.
Friday’s figures met this threshold, signaling an abrupt economic downshift. Consequently, investors sought safer assets, leading to declines in major stock indices: the S&P 500 dropped 2%, the Nasdaq 2.5%, and the Dow 1.5%. This trend continued into Monday with further sell-offs overseas.
The crypto market’s rapid decline raises questions about its role as either a speculative asset or a hedge against inflation and recession. Despite hopes that crypto could act as a risk hedge, the recent crash suggests it remains a speculative investment.
Since the downturn, the crypto market has seen its largest three-day sell-off in nearly a year, losing over $500 billion in market value. According to CoinGlass data, this bloodbath wiped out more than $1 billion in leveraged positions within the last 24 hours, including $365 million in Bitcoin and $348 million in Ether.
Khushboo Khullar of Lightning Ventures, speaking to Bloomberg, argued that the crypto sell-off is part of a broader liquidity panic as traders rush to cover margin calls. Khullar views this as a temporary sell-off, presenting a potential buying opportunity.
Josh Gilbert, an eToro market analyst, supports Khullar’s perspective, suggesting that the expected Federal Reserve rate cuts could benefit crypto assets. “Crypto assets have sold off, but many investors will see an opportunity. We see Federal Reserve rate cuts, which are now likely to come sharper than expected, as hugely positive for crypto assets,” Gilbert told Coindesk.
Despite the recent volatility, crypto continues to make strides toward mainstream acceptance. Notably, Morgan Stanley will allow its advisors to offer Bitcoin ETFs starting Wednesday. This follows more than half a year after the introduction of the first Bitcoin ETF. The investment bank will enable over 15,000 of its financial advisors to sell BlackRock’s IBIT and Fidelity’s FBTC. This move is seen as a significant step toward the “mainstreamization” of crypto, given the lengthy regulatory and company processes in major investment banks.
The recent crypto market downturn highlights its volatility and the broader economic concerns affecting all risk assets. While some analysts see the current situation as a temporary sell-off and a buying opportunity, others caution against the speculative nature of crypto. As the market evolves, its role as a mainstream alternative asset continues to grow, marked by increasing institutional acceptance and new investment opportunities.
