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4 things to know as cryptocurrencies such as Bitcoin (and stablecoins) melt down

Bitcoin and other cryptocurrencies are being caught up in the storm impacting all kinds of markets, including stocks. The plunge in a type of crypto called TerraUSD is raising special concern.

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A Bitcoin logo is seen during the Bitcoin 2022 Conference at Miami Beach Convention Center in Miami on April 8. Crypto such as Bitcoin have tumbled in recent days as part of a storm hitting all kinds of markets.
A Bitcoin logo is seen during the Bitcoin 2022 Conference at Miami Beach Convention Center in Miami on April 8. Crypto such as Bitcoin have tumbled in recent days as part of a storm hitting all kinds of markets. Marco Bello | Getty Images

As the old maxim goes, sometimes the bigger they are the harder they fall.

Bitcoin and other cryptocurrencies surged during the pandemic, turning many amateur investors into millionaires, on paper at least. Bitcoin, for example, hit an all-time of nearly $68,000 in November.

Today, it's trading at less than half that amount as part of an intense sell-off that has accelerated in recent weeks.

It's been even worse for an area of cryptocurrencies called stablecoins, in particular one called TerraUSD that has tumbled hard.

Here's a look at what's going on.

So why are cryptocurrencies down so much?

Put simply, cryptocurrencies got caught up in the maelstrom affecting broader markets.

Stocks, bonds and other assets have tumbled in recent weeks as investors fear the Federal Reserve will need to raise interest rates aggressively to fight inflation, raising the prospect of a recession.

The falls in broader markets have affected cryptocurrencies, with Bitcoin down more than 20% in the past two weeks.

The selloff has been worse for some of the newer cryptocurrencies such as Dogecoin, which started as a joke and then took off, in part, thanks to the support of billionaire Elon Musk.

It's a stark reversal from a few months ago, when actors such as Matt Damon and Larry David were pitching crypto companies in Super Bowl commercials.

Actor Matt Damon speaks onstage during Focus Features'
Actor Matt Damon speaks onstage during Focus Features' "Stillwater" panel at the Deadline Contenders Film: New York event in New York City on Dec. 4. Damon has appeared in commercials for a company called Crypto.com. Michael Loccisano | Getty Images for Deadline

Wasn't Bitcoin supposed to be a hedge against inflation?

Yes, but it hasn't turned out to be one, at least so far.

Bitcoin was the first cryptocurrency and is still the most popular of them all.

Proponents of Bitcoin had long touted the digital currency as an inflation hedge, in part because there is a finite amount of it.

But Bitcoin has tumbled hard, along with stocks.

If Bitcoin was seen as a true hedge against inflation, it should be rallying given that inflation is at its highest in decades.

"A lot of people thought it would be an inflation hedge, but there's really very little data to prove that," says Randy Frederick, a managing director at Charles Schwab who covers cryptocurrencies. "Most recently, it has not moved up as the market has moved down. Had it been an inflation hedge, it might have done that."

In fact, Bitcoin is reacting just like any other riskier asset such as stocks.

Still, the argument of Bitcoin as an inflation hedge is not quite dead either, experts say.

Bitcoin may be the oldest of the cryptocurrencies, but it has only been around for just over a decade.

That means analysts don't have a lot of historical data. Frederick, for instance, says we'll know a lot more about how Bitcoin behaves through more market cycles.

A sign that reads
A sign that reads "Bitcoin is going to the moon" is seen during the Bitcoin 2022 Conference at Miami Beach Convention Center in Miami on April 8. The expression has become popular among some Bitcoin enthusiasts. Marco Bello | Getty Images

What about stablecoins?

Cryptocurrencies have spawned offshoots and led to more sophisticated – or as some regulators see them, dangerous – assets.

Stablecoins such as tether or USD Coin are a type of crypto that are gaining in popularity.

Most stablecoins are meant to be backed by real assets. That means that for every dollar-worth of a stablecoin, the exchange or the seller would need to set aside the equivalent in a real fiat currency, such as the dollar, or the equivalent amount in an easy-to-trade security such as government bonds.

That's what is supposed to make them more "stable." If the buyer of the stablecoin wanted to cash out of that virtual currency, it should be easy since the exchange is supposed to have the money at hand, similar to how bank customers expect to be able to withdraw their money at any time.

But regulators have long questioned whether exchanges really do keep those hard assets aside in an account. Moreover, stablecoins have created their own offshoots.

One of them, TerraUSD, has run into big trouble in recent days. TerraUSD is known as an algorithmic stablecoin because it relies on financial engineering to maintain the 1-to-1 peg between the stablecoin and the backup assets.

TerraUSD is even pegged to another cryptocurrency called Luna.

The stablecoin cratered to 14 cents as of Friday, well below the $1 it should theoretically be fetching.

Pat Tschosik, a senior portfolio strategist with Ned Davis Research, says TerraUSD's troubles could be part of a potential winnowing of cryptocurrencies.

"It's still really young," he says, of crypto. "You know, this is still a developing area. There is going to be speculation. There is going to be booms and busts along the way, and this is all still new."

Traders work on the floor of the New York Stock Exchange (NYSE) on May 12, 2022 in New York City. Stocks and other markets have tumbled in recent weeks over economic fears.
Traders work on the floor of the New York Stock Exchange (NYSE) on May 12, 2022 in New York City. Stocks and other markets have tumbled in recent weeks over economic fears. Spencer Platt | Getty Images

So where do we go from here?

More broadly, the outlook for cryptocurrencies will likely continue to be tied to broader market sentiment.

But the falls in cryptocurrencies and the collapsing value of TerraUSD stand to alarm policymakers such as Treasury Secretary Janet Yellen and Securities and Exchange Commission Chair Gary Gensler.

That may lead to more regulation of cryptocurrencies in general.

Sustained falls in cryptocurrencies could also raise doubts about the future of the virtual money more broadly, just when there had been signs that it was trying to mature, with more and more professional investors starting to trade them.

Last month, Fidelity, the largest provider of retirement plans, announced it would allow employers to offer Bitcoin in 401(k) plans, although the Department of Labor has cautioned employers against doing that.

Still, cryptocurrencies also have a lot of fanatical followers who are used to steep selloffs and reversals, and many of them believe that this is a short-term decline.

Tschosik from Ned Davis Research, for example, is "long-term bullish on Bitcoin," he says. "We still see the acceptance of it continuing to expand."

He points to millennials, for example, who want to invest in cryptocurrencies because they seem as as a "legitimate option."

Not everybody agrees, however, leaving the future of cryptocurrencies uncertain.

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Transcript :

SCOTT SIMON, HOST:

Bitcoin and other cryptocurrencies surged in value during the pandemic and turned many amateur investors into millionaires, at least on paper. But today, crypto is crashing, and Bitcoin is trading at less than half of what it was at its all-time high back in November. NPR's David Gura joins us now. David, thanks so much for being with us.

DAVID GURA, BYLINE: Good to be with you.

SIMON: And why are cryptocurrencies being hit so hard?

GURA: Well, they've gotten caught up in this broader market selloff we've seen. Investors are shying away from speculative assets at a time when interest rates are going up, inflation is at a 40-year high, and there's fear on Wall Street we could be headed for a recession. This is proving very unsettling, especially to first-time investors who bought into Bitcoin recently. Remember; it wasn't too long ago people thought cryptocurrencies were going mainstream. Just back in February, actors like Matt Damon and Larry David were promoting crypto companies in Super Bowl ads.

SIMON: The Larry David ads are very funny. Let's talk about Bitcoin. It was supposed to be a hedge against inflation, right?

GURA: Yeah, so Bitcoin is the oldest and the most popular cryptocurrency, and proponents have long touted it as a safe place to be when prices are rising. That was the promise, but it has not been the reality, at least so far. We're seeing a tight correlation between the performance of tech stocks and cryptocurrencies. Now, if Bitcoin was a real hedge against inflation, it should be going up while tech stocks are going down. Randy Frederick covers cryptocurrencies for Charles Schwab.

RANDY FREDERICK: A lot of people thought that it would be an inflation hedge, but there's really very little data to prove that. And, in fact, not just recently, but over the long haul, that hasn't been the case.

GURA: Now, Frederick is not willing to rule out Bitcoin could be an inflation hedge someday. He stresses that even though Bitcoin is the oldest cryptocurrency on the block, it's only been around for a little over a decade, so analysts don't have a lot of historical data to work with, and he'd like to see how it holds up during more market cycles.

SIMON: And what about these cryptocurrencies - I'm hearing a little more about them now - called stablecoins?

GURA: Yeah. Cryptocurrencies have spawned offshoots that are more sophisticated, potentially more dangerous, according to regulators, and stablecoins are one example. The idea behind many of them is they're backed by real assets like the dollar or a government bond. That's supposed to make them safer because when you want to get rid of them, the seller should have money on hand to cash you out. But there are other stablecoins that are not backed by real assets, and one of them that's made headlines recently is called TerraUSD. Instead of being pegged to the dollar or a government bond, it's pegged to other assets, including other cryptocurrencies, which makes it much riskier. And as we saw this week, despite it being called a stablecoin, it's not stable at all. The value of TerraUSD has cratered to a small fraction of what it was.

Pat Tschosik is a senior portfolio strategist with Ned Davis Research. And while he acknowledges this was unsettling, he predicts there will be a winnowing of the crypto space.

PAT TSCHOSIK: This is still a developing area. You know, there's going to be speculation. There's going to be booms and busts along the way. And this is all still new.

GURA: Stablecoins have come under scrutiny from regulators. And with what's happened, that's likely to intensify.

SIMON: So what happens next? Where do we go from here? - all of those obvious questions.

GURA: Well, analysts expect it's likely the outlook for crypto will continue to be tied to broader market sentiment, but that TerraUSD crash is likely to alarm policymakers. Treasury Secretary Janet Yellen has warned of the dangers of Stablecoins, and S.E.C. chair Gary Gensler has called crypto in general the Wild West. And both of them have signaled more crypto regulation is on the way. And the regulations are coming as there are signs that cryptocurrencies are becoming more popular. A few weeks ago, Fidelity, the largest provider of retirement plans, announced it plans to let employers offer Bitcoin in their 401K's. Tschosik calls that a major milestone. He says he's still bullish on Bitcoin despite the selloff and the threat of more regulation. And a big reason for that, Scott, he says, is how much room it still has to grow and how popular it continues to be with young people in particular.

SIMON: NPR's David Gura, thanks so much.

GURA: Thanks, Scott. Transcript provided by NPR, Copyright NPR.

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