Similarities and differences between 2022 crypto crisis and the 2008 sub-prime crisis


I witnessed the 2008 crisis closely (used to work at Lehman Brothers), and am seeing (with lot of foresight and predictions that came true) the current “crypto crisis” 2022. Here are some quick analogies,

Regulators did not understand, and get around to regulating the underlying asset classes well.

- Sub-prime mortgages, mortgage linked securities like CDOs, etc.

- Cryptocurrencies, tokens, USD pegged stable coins

- Leverage /rehypothecation of client assets, etc.

The “asset classes, securities and allocation of capital” became so deeply linked that nobody could easily identify the risks, including liquidity risks, leverage risks, etc. Unless anybody chose to look under the hood by asking simple fundamental “why” questions, which nobody bothered to as long as the companies were making lot of money

Every single breakdown initially looks isolated and contained, until the next one happens and the next one. Eventually it's realised that it was nothing more than a leveraged MLM (multi level marketing) scheme with no underlying fundamental cashflows or use cases in the financial assets.

Clear frauds by operators, driven by greed,

- Mis-selling to institutions who have no ability to comprehend this

- Misuse of client funds for leverage

- Misrepresentations to investors

- And so on..

Many of the “smart” investors (VCs especially, fund managers, banks etc.) went so deep into these investments, and apparently did not do enough fundamental analysis. All they had to ask, critically, was,

- What’s the use case, where are the cashflows and when will they come?

- Where is value being created and how is it measured?

- What are the risks if these securities get regulated/banned, stable-coins crash, liquidity dries up?

- Is the growth only due to excess free capital?

- Are there any conflicts of interest .. like exchange using client funds to support related party's trading, leverage and investing?

- And many more common sense questions..

Retail investors have lost and will lose out, as they always tend to do.

There are some “small scale bailouts” happening, though, fortunately none by the governments this time (tax payers spared 😊)

Fortunately, one major difference in the current crypto crisis and 2008 crisis is that crypto crisis is reasonably contained to top of the financial pyramid and not as spread out as 2008 crisis was.

Some upcoming outcomes in current crisis,

- Regulators will talk big, lot of senate hearings will happen, most likely nobody will go to jail for the mis-appropriations.

- Regulators may regulate the “crypto related products” very heavily

- Crypto VCs may stop “screaming cryptos, blockchain and decentralization” (and likely web3 also), and may go back to real business investing (though I have some doubts) at sane valuations and stop their self-congratulatory behaviour stemming from random baseless unicorns in their portfolios.

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