This week's vicious crypto crash shows a crisis of confidence in the entire ecosystem

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This week's vicious crypto crash shows a crisis of confidence in the entire ecosystem
Bitcoin has tumbled to far below November's high of close to $69,000.Dado Ruvic/Reuters
  • The crypto market is facing a crisis of confidence following the implosion of Luna and Terra.
  • Crypto investors often point to stablecoins as essential to growing the sector, but now some are questioning their viability.
  • The crypto bear market highlights just how precarious the $1.2 trillion sector is as it relies on the hope of others to drive prices higher.
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There's a crisis of confidence roiling the cryptocurrency market following the implosion of Luna and its related stablecoin, Terra, and the lack of confidence is spreading through the ecosystem.

Terra depegged from $1 earlier this week and is now trading at around 50 cents, as the algorithmic stablecoin erased more than $5 billion in market value virtually overnight.

Stablecoins are meant to simply hold their value and remain liquid to facilitate trades in other cryptocurrencies. But Terra's destruction show stablecoins can have all the risk of crypto without any of its upside potential.

The value destruction in Luna was even worse, as it lost $30 billion in market value after declining by 99% over the past week.

Now some crypto investors are awakening to the fact that the value of what they own is reliant solely on supply and demand dynamics, with the hope that they'll be able to sell the coins to someone else at a higher price in the future. But that hope doesn't provide comfort when crypto is in a full-blown bear market, having erased nearly $2 trillion in value since its November peak.

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Unlike stocks, cryptocurrencies don't have an underlying stream of earnings that investors can size up, project into the future, and value based on time-tested strategies like discounted cash flow models. Instead, crypto investors can only hope that confidence in the sector is restored and adoption continues to move forward, driving more demand for what they already own.

That may be difficult as Terra's stablecoin implosion is only likely to trigger intense scrutiny from regulators over the coming months. It's also difficult because the sharp decline in Terra has spilled over to the world's largest stablecoin, Tether.

Tether is worth more than $80 billion and briefly saw its value depeg from $1 and fall 5% to $0.95 on Thursday. Many investors have questioned whether Tether's reserves are actually invested in liquid, zero-risk securities like US treasuries.

The stability of Tether is essential to restoring confidence in the crypto market, and Thursday's showing is not a good sign. Another issue crypto investors are grappling with is whether the implosion of Terra and the weakness in Tether represents a systemic risk to the broader crypto and financial markets. If it does, regulators could come down hard on the sector, which has largely been left to itself ever since bitcoin was introduced in 2009.

For a market that is solely reliant on the dynamics of supply and demand, it's crucial that the crypto market quickly cleans up its act and restores confidence to investors, otherwise the cascading waterfall seen in Terra and Luna this week could spread to other crypto coins.

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And restoring confidence in the crypto market could be hard to do given its decentralized nature, which once again highlights why confidence among its users and investors is crucial to driving future price appreciation.

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