How Crypto Became the New Subprime

Since then, however, prices have crashed, wiping out around US$1.3 trillion in market capitalisation. As of Thursday morning (Jan 27), Bitcoin’s price was almost halfway down from its November peak. So who is being hurt by this crash, and what might it do to the economy?

Well, I’m seeing uncomfortable parallels with the subprime crisis of the 2000s. No, crypto doesn’t threaten the financial system; the numbers aren’t big enough to do that. But there’s growing evidence that the risks of crypto are falling disproportionately on people who don’t know what they are getting into and are poorly positioned to handle the downside.

What’s this crypto thing about? There are many ways to make digital payments, from Apple Pay and Google Pay to Venmo. Mainstream payment schemes, however, rely on a third party – usually your bank – to verify that you actually own the assets you’re transferring. Cryptocurrencies use complex coding to supposedly do away with the need for these third parties.

Skeptics wonder why this is necessary and argue that crypto ends up being an awkward, expensive way to do things you could have done more easily in other ways, which is why cryptocurrencies still have few legal applications 13 years after Bitcoin was introduced. The response, in my experience, tends to take the form of incomprehensible word salad.

Recent developments in El Salvador, which adopted Bitcoin as legal tender a few months ago, seem to bolster the skeptics: Residents attempting to use the currency find themselves facing huge transaction fees. Still, crypto has been effectively marketed: It manages both to seem futuristic and to appeal to old-style goldbug fears that the government will inflate away your savings, and huge past gains have drawn in investors worried about missing out. So crypto has become a large asset class, even though nobody can clearly explain what legitimate purpose it’s for.

But now crypto has crashed. Maybe it will recover and soar to new heights, as it has in the past. For now, however, prices are way down. Who are the losers?

As I said, there are disturbing echoes of the subprime crash 15 years ago.

Crypto is unlikely to cause an overall economic crisis. It’s a big world out there, and even US$1.3 trillion in losses is only about 6 per cent of US gross domestic product, a hit that’s an order of magnitude smaller than the effects of falling home prices when the housing bubble burst. And activities like Bitcoin mining, while environmentally destructive, are economically trivial compared with homebuilding, whose plunge played a large role in causing the Great Recession.

Still, some people are being hurt. Who are they?

Investors in crypto seem to be different from investors in other risky assets, like stocks, who consist disproportionately of affluent, college-educated whites. According to a survey by the research organization NORC, 44 per cent of crypto investors are nonwhite, and 55 per cent don’t have a college degree. This matches up with anecdotal evidence that crypto investing has become remarkably popular among minority groups and the working class.

NORC says that this is great, that “cryptocurrencies are opening up investing opportunities for more diverse investors.” But I remember the days when subprime mortgage lending was similarly celebrated – when it was hailed as a way to open up the benefits of homeownership to previously excluded groups.