We stand now on the precipice of one of the darkest corrections I have seen in tech since I started by PR career in 2008 — a combination of a likely recession and industrial hubris on a scale that is only as bad as it is because of how good everybody thought it was. We are barely a quarter past a time when everybody was assuming that cryptocurrency valuations would only ever go up, and when startup valuations could never possibly come down, where companies received outsized funding rounds, only to lay off hundreds of people at a moment’s notice based on “bad market conditions.”
This particular crash is one that’s been caused by the dual forces of startup and cryptocurrency hubris. I wrote previously about how cryptocurrency is still looking for any kind of utility, and now the crypto world seems to be falling apart, with three major crypto firms either collapsing under the weight of margin calls (I’ll get to that shortly) or simply not having enough money to do business (or both.)
For a layman’s explanation — or perhaps for people who think “nobody could be that stupid, right?” — what appears to be happening is that many of these cryptocurrency companies have been using their funds to do margin-based loans. These futures contracts can be many things, but the most common ones are “shorts” or “longs,” meaning that you “short” (currency go down) or “go long” (currency will go up) on a particular thing such as Bitcoin or Ethereum. These loans are attractive, because you’re able to buy a contract for 100 Ethereum, or 100 BTC, without having to actually own them, gaining the outsized returns if you sell above the price you paid for the contract. And when you have that contract, you also need to provide a certain amount of money (collateral) just in case the particular call you make — for example, you go “long” on Ethereum and say it’ll go above $1100 — goes underwater (Ethereum’s price hits $980).
You may be wondering why everybody doesn’t buy futures contracts, and the answer is quite simple: they have a necessary but nasty feature called “margin calls,” meaning that beyond a certain deficit in value of the contract, you have to provide money to the broker to keep using it. Most brokers — or smart contracts — have a certain amount of collateral you’re required to have on hand, and without it, the contract will be sold at a massive loss that you now owe the broker, as well as having lost all the money you put in. Here’s a little explainer that’s smarter than mine.
