The next crypto crash and how it’s going to happen. My response to Meet Kevin.
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When will the next crypto crash happen? How bad will it be and how will it happen? My friend Meet Kevin made a video called How the Complete Collapse of Cryptocurrencies would Happen. He talked about how the lending / borrowing system of crypto is fundamentally broken. His main issue is this: a potential flash crash of crypto prices would trigger a liquidity crisis due to people running to withdraw / sell their tokens on BlockFi, Gemini, Coinbase, Binance, etc. When people ask to redeem their stable coins it’s possible they will not have any claim to those coins at all. If that were to happen, the prices of stable coins would crash and subsequently so would the price of Bitcoin, Ethereum, Dogecoin, etc.
Full disclosure: Kevin and I have a couple hundred thousand dollars worth of cryptocurrencies in our portfolio so we both have a stake in the success of crypto.
Here’s an example: I sign up to Gemini and I give them $100. With that $100, Gemini can do whatever they want, they can increase their balance sheet, pay people, buy Bitcoin, etc. What they give us in return is a sable coin – GUSD which is Gemini’s stable coin. For each stable coin they create, they have to have on their balance sheet as a requirement in USD – and at any time I should be able to take my GUSD and redeem it for exactly what I made a deposit for back in dollars. Here’s where things get tricky .
This only covers the creation of stable coins – not the loans. So, if I give them my $100, they can technically lend that money out to another institution. So let’s say you sign up to BlockFi and you deposit your $100 and they give you GUSD but guess where that $100 stable coin could be coming from? That coin could have been borrowed from Gemini which was from my original deposit. Well then that $100’s worth of GUSD can be loaned out again to another crypto broker who can then loan it to someone else. Now all of us see in our account $100 GUSD or USDC or Tether or whatever stable coin but actually – that $100 GUSD was first created from my original deposit. That $100 stable coin can be loaned out indefinitely from one place to the next and that’s where things get scary.
If someone was to take out a loan on margin, and we get a flash crash of prices, that could trigger people to pay their margin and forced to sell their tokens. If this happens to many people, all of them would run to claim their tokens. What happens if the loan then exceeds the value of the collateral for margin? We can get a liquidity crisis and a subsequent collapse.
The solution: if this were to happen it would hopefully be localized to the businesses that loan out money. The larger crypto brokers would be able to cover by dipping into their cash reserves or by raising more funds. Another possible solution is to only accept non crypto related collateral so that it’s shielded away from price fluctuations. This would also be helped if we had a Bitcoin ETF (that would increase market cap and subsequently stabilize prices reducing the risk of a flash crash).
Another way to solve this is by doing exactly what the banks would do if there was a “run on the banks”. Withdrawals would be paused for several days. This is why we have withdrawal limits and waiting times, so the chances of this would be reduced. However, the best solution is DeFi. Decentralized Finance. Here’s how.
In the future we will have decentralized versions of Coinbase, Gemini, Blockfi, etc. where those platforms will be run on smart contracts dictated by code. They would also have stricter collateral control and because they are on the blockchain, they would also be a lot more transparent with regards to how risky those investments / loans / margins would be. As of right now, there is no way to tell how leveraged the current system is. It’s a risk that everyone should be aware of.
*None of this is meant to be construed as investment advice, it’s for entertainment purposes only. Links above include affiliate commission or referrals. I’m part of an affiliate network and I receive compensation from partnering websites. The video is accurate as of the posting date but may not be accurate in the future.