What's Driving the Crypto Crash?

Exploring the transformation of value in the digital age

By Michael J. Casey, Chief Content Officer

May 21, 2021

Sponsored by

If you were forwarded this newsletter and would like to receive it, sign up here.

Identifying a core reason for the gut-wrenching plunge in cryptocurrency prices this week is complicated because falling prices create their own reality, prompting investors to sell even more. In this case, this was exacerbated by debt. As prices fell, investors who'd borrowed to finance their bets had to liquidate them to cover their positions. This is an ever-present danger in all financial markets but that it played out so violently this time speaks to how deeply lending and borrowing is now integrated into crypto.

This hints at systemic challenges, a rich topic that we'll save for another newsletter. This week's column addresses a system of a different kind: the energy economy. We take on one of the popular narratives that contributed to the sell-off – the idea, invigorated by Tesla's reversal on bitcoin payments last week, that investors and companies should avoid it due to the high energy consumption involved in mining.

The mainstream discussion on this issue is frustratingly superficial, but so, too, is the standard "whataboutism" and denialism of the crypto community. I suggest we consider how bitcoin can fit into a system-wide design of the economic incentives that dictates how society generates, distributes and uses power. Doing so leads to a different conclusion, with mining viewed not as a toxic creator of greenhouse gases but as a driver of renewable energy development.

This will be a major topic at next week's Consensus by CoinDesk, a huge, four-day affair with more than 300 speakers, including Federal Reserve Governor Lael Brainard and Bridgewater Associates founder Ray Dalio. (Register here.) In particular, my "Money Reimagined" podcast co-host Sheila Warren of the World Economic Forum and I will lead two one-hour special sessions on CoinDesk TV on Monday and Friday discussing the opportunity and challenges that crypto and blockchain pose for companies and investors looking to meet environmental, social and governance (ESG) objectives.

For this week's podcast, we travel to Haiti to address a topic that falls under the "S" in ESG: how the ugly legacy of international debt keeps the poorest, aid-dependent countries forever removed from capital markets, and whether new blockchain systems of money and record-keeping can break that cycle and help these countries gain control of their destiny. We talk to Terry Tardieu, a Haitian author, entrepreneur and politician who represents Petion-ville in the Chamber of Deputies, and Daniele Jean-Pierre, the co-founder and COO of Zimbali networks, which delivers smart ledger solutions for the decentralized economy.

A message from Tezos

You've heard about crypto, DeFi, and clean NFTs. Now discover Tezos.

Artists, conservationists, entrepreneurs, comic book fans, and collectors around the world are envisioning how to build, create, and use Tezos in new and unexpected ways. Discover how people are re-imagining the world around you on Tezos.

Hey Elon, Embrace Bitcoin for a Cleaner Grid

Illustration: Rachel Sun/CoinDesk

The factors contributing to this week's crypto market rout were many – from excessive leverage to China's regulatory bluster – but two stories last week play a trigger role in shifting sentiment to the negative: the Colonial Pipeline ransomware attack and Elon Musk's newfound concern about bitcoin's carbon footprint.

The first, which resulted in the pipeline owners acceding to the hackers' demand for payment in bitcoin, inevitably revived the public misconception that cryptocurrency is rife with criminality and raised fears of a U.S. regulatory backlash.

The second took a once-popular cheerleader out of the mix, drew attention to bitcoin's vast energy consumption and raised the idea that environmentally conscious companies and institutions might sour on it as an investment.

Yet, taken together, those two developments point to an opportunity to shape a completely different narrative, one that's far more positive on the relationship between bitcoin and energy. This column attempts to do that. One can only hope Musk is reading.

Optimizing Energy Systems

Let's start with these points:

Climate change is real, accelerating and demanding a major shift to renewable energy.
Digitalization means that, as currently designed, our energy infrastructure is increasingly vulnerable to attacks like the one that shut down the Colonial Pipeline and interrupted fuel deliveries along the U.S. East Coast.
Energy is vital to broad-based economic prosperity.
Bitcoin, whether people like it or not, is here to stay.
The economics of bitcoin pits miners in constant competition with each other for the lowest-cost, most efficient source of energy. And they will go anywhere to tap it.
Thanks in part to some ever-improving technology, renewables are already the lowest-cost energy source in the world. (By contrast, fossil fuels are commodities that are likely to become more expensive over time.)

With all that in mind, I'll make the argument not only that bitcoin can be greener with far lower carbon emissions but can also help society optimize its energy system for efficiency, sustainability and security.

Bitcoin can help foster a more decentralized energy system than the one we have now. Our electrical grids are mostly built on centralized models, with large-scale generation plants and heavy-duty transmission lines carrying power from generation centers to the users in the regions. The fuel distribution supply chain is also centralized, reliant on single refineries that attach to single, long pipelines such as that of Colonial's.

This structure made sense originally because, until humans understood the costs to the environment, the cheapest sources of energy were fossil fuel-based. Unlike abundant and distributed solar and wind sources, these were only available in certain places and required large-scale industrial activity to convert them into usable power. So long as we keep the existing hub-and-spoke model in place, we continue to justify and serve the fossil fuel industries that feed into it.

The inefficiencies of the existing system are now clear. It's expensive to build, maintain and operate long-distance transportation infrastructure and, in the case of electricity transmission, significant amounts of power are lost between the generating plant and the final destination.

The system design also makes it an especially appealing target for hackers. Taking down a single delivery element, such a pipeline, supporting a large economic community offers an attractive payoff relative to the cost of organizing and deploying an attack. By contrast, it's much less profitable for attackers if they have to go after multiple mini-systems to achieve the same impact.

We need a decentralized system, one that taps energy sources that are closer to users. Solar power in particular, and wind to a lesser degree, allow this. The model implies a patchwork of interconnected microgrids, each primarily servicing local residents but also offering backup to other users outside their community in case their services are interrupted or insufficient.

Designed properly, such a system would emit much less CO2, it would be more efficient and, because of its wide distribution and built-in "redundancy" or backups, would be less vulnerable to attack. Hackers would have little incentive to act as they would have to break into multiple grids to acquire the same financial leverage that the Colonial Pipeline attackers obtained in holding the entire eastern seaboard to ransom.

Tesla drivers have no use for the gasoline transported by pipelines. But one can imagine them happily tapping into simple, low-cost charging stations that microgrid operators set up around the country to help monetize their operations. This is the kind of system Elon Musk should want to see built, in other words.

Bitcoin as a Force Multiplier

What does this have to do with Musk's new whipping boy, bitcoin?

It's that bitcoin mining can help communities overcome the one obstacle that disincentivizes them from developing renewable microgrids: the significant cost involved in the initial outlay.

Bitcoin mining is location agnostic. It can be easily deployed anywhere there is available, sufficiently low-cost power and it immediately generates value. This is why many bItcoin mining operations in the U.S. are increasingly striking deals with developers of renewable energy infrastructure, such as microgrids based on solar, wind or small hydro dams.

As Harry Sudock, vice president of strategy at mining infrastructure provider GRIID explained in a recent episode of our "Money Reimagined" podcast, miners can provide revenue guarantees to these operators, allowing them to raise the capital needed to start building their systems.

It goes further than that. As has been seen in Texas, where Peter Thiel-backed Layer1 is working, grid operators can strike useful deals with miners such that they consume excess power in periods where demand is low but turn their machines off when demand surges. This helps solve the so-called "duck curve" problem caused by household solar panels, which generate a lot of otherwise wasted power during daylight hours when people are away from home at their workplaces and not enough in the evenings when they've returned home. It makes the grid operator's perennial load management challenges easier to address.

There's a real opportunity here for policymakers to accelerate the buildout of renewable energy and build a more sustainable, secure system. But they need to start looking at bitcoin differently and think about what incentives could encourage bitcoin-underwritten energy development projects.

Bitcoin miners, whose operations often run on low margins, are ruthless in deciding what energy source to use. If it's cheap they'll use it, regardless of where it comes from. If explicit or implicit subsidies make fossil fuel energy viable for mining, they will go there. If we don't change the dynamic, bItcoin's carbon footprint will continue to be problematic.

Bitcoin is not a moral good or bad. It is an economic system, one that's here to stay, whether we like it or not.

Decentralization, in the form of renewable energy created closer to where it's consumed, is key to a more sustainable future. Bitcoin, as the decentralized value network, can help engineer that.

Off the Charts

It's All About Perspective

It's striking that this week's market sell-off precedes the pandemic-be-damned, in-person Bitcoin conference that's taking place in Miami next month – one that Bitcoin Magazine is putting on in the wake of our own, virtual Consensus by CoinDesk. It's expected to be a rather excessive affair. I'm not going, but many people I know say they're really just going for the parties. It's hard not to worry that a super-spreader moment looms. Even if it's all innocent, as CoinDesk contributor Jeff Wilser points out, there's something a bit unreal about the whole Miami crypto scene right now.

It was in Miami, at the North American Bitcoin Conference in late January 2014, that I first got wind, as a Wall Street Journal reporter, that people were having problems withdrawing funds from Mt. Gox, the most important bitcoin exchange at that time. A few weeks later, Mt. Gox collapsed and the price of bitcoin, which had increased fivefold in the weeks before the conference, plunged all the way to $200, where it stayed for some time. The prior price rally had turned the NABC into a raucous, celebratory affair, albeit with far less of the world's attention on participants than is now applied to the crypto community. I wonder what the mood will be like at our twin competing conferences this time?

The real lesson from that 2014 boom-bust moment, however, was that, in the grand scheme of things, it was really quite insignificant. These two charts, offering two different time perspectives, help to illustrate that.

At the time, the price action seemed wild and dangerous. Looking back from 2021presents a very different picture.

The orange arrow: that's the Miami bubble followed by the Mt. Gox "crash."

A message from Residual

Our software platform leverages blockchain's near instantaneous, immutable settlement capabilities and eliminates latency and costly transaction fees. By bridging the gap between traditional financial services and today's cutting edge technology, unFederalReserve can help thousands of non-bank lenders and borrowers around the world. The eRSDL community is diverse and inclusive, encourages engagement and ongoing support for each other, and is dedicated to DeFi projects that de-risk at every opportunity. We are pleased to welcome the first product in our ecosystem, the Reserve Lending platform - the beginning of a robust treasurer's tool kit that will streamline future banking transactions.

The Conversation

Musk Vs McObnoxious

Illustration: Rachel Sun/CoinDesk

"The conversation" hardly seems like the right title for this section this week. While it might seem preferable just to ignore the unseemly Musk-Crypto Twitter spat this past week, it's an unavoidable element of where we are right now in this social media, meme-infused moment within the battle for money. It bears documenting.

Why exactly the richest man in the world thought it was necessary to stir up the crypto hornets nest is unclear, but in doubling down on his claims about the environmental harm of bitcoin while continuing to talk up dogecoin, that's exactly what he did. By the same token, the bitcoin community didn't exactly elevate the conversation.

There was so much back and forth between Musk and bitcoiners there's no way to capture it here, so we'll focus on one particularly quirky battle, the one he had with "What Bitcoin Did" podcaster Peter McCormack.

We start with the tweet that did all the harm, the one that sent bitcoin into a tailspin late Friday last week.

McCormack decided to go on the offensive. In a tweet storm, he drew a stark dichotomy between bitcoin, which he described as "the only meaningfully decentralized cryptocurrency," and Musk's favorite meme reference, dogecoin, "a joke" that "serves little purpose beyond coin-flipping."

To which Musk replied:

A few days later, after McCormack had changed his Twitter name to "Peter McObnoxious," he took issue again with Musk after the Tesla CEO had sent another tweet celebrating dogecoin.

As the replies built up, many from other prominent bitcoiners, Musk got defensive, drawing in his past as a founder of a certain payments app.

This was too much for McCormack.

A message from Coindesk

Countdown to #Consensus 2021

COVID-19 catalyzed a rapid advance in research and deployment of digital currencies by central banks, with nearly every such bank in the world researching or undertaking these projects.

Next week at Consensus by CoinDesk, our virtual big-tent conference, we explore the pace of development, lessons learned and how these will interplay with bitcoin.

Join our Explorations track "The Central Banks Strike Back: CBDCs and Monetary Innovation," sponsored by Hedera Hashgraph, with Lord Meghnad Desai of the Official Monetary and Financial Institutions Forum (OMFIF) Advisory Board, Governor John Rolle of the Bahamas Central Bank, Christian Catalini of Diem Association and more at Consensus by CoinDesk, May 24-27. Register today.

Relevant Reads

Markets Get Stress-Tested

The very sharp price declines in crypto markets this week offered a window into how they perform under stress now that Wall Street institutions are participating in them while new lending and derivative instruments have added different avenues for speculation. And sure enough, the scale of what happened was magnified. As Omkar Godbole reported in his initial account, $8 billion in liquidations were triggered as falling prices forced borrowers to sell their positions and repay loans, creating a self-perpetuating cycle of downward price pressure.

In a post-mortem podcast on what happened, Nathaniel Whittemore dug into the sheer magnitude of the liquidations. The total had run to $10 billion by his calculation, with a whopping 775,000 traders' accounts triggered. The remarkable thing was that traders kept borrowing money to put on leveraged loans to try to buy the dip but the price kept falling, which meant those trades had to be liquidated as well.

While all of this is painful, the process also serves to cleanse the market of a lot of overhanging debt. And that's what lenders said had happened, with the crash leading to an unwind of "excessive leverage," according to a report by Nate DiCamillo.

A message from CoinDesk

Bitcoin Miner Metrics: Hashrate and Thermocap

How is hashrate calculated? What does thermocap represent? What do hashrate ribbons say about bitcoin price cycles? This research note looks at Bitcoin miner metrics and how investors can use them to glean insight into the asset's price and network fundamentals. Download the free report here.

ATTENTION: Scammers have been sending fraudulent emails with links to sites disguised to look like coindesk.com. If you are in doubt about a link, type https://www.coindesk.com directly into your browser; do not copy and paste. Remember, if something seems too good to be true, it probably is.