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Crypto Crash 2022, Explained: What is Cryptocurrency and Why Has it Lost Most of its Value So Quickly?

If you invested in cryptocurrency just six months ago, you're bleeding money now.

PUBLISHED MAY 25, 2022 12:00 A.M.
Bitcoin and other cryptocurrencies lost more than half of their value in just six months.
Bitcoin and other cryptocurrencies lost more than half of their value in just six months. Serg Dementev / Pixabay   Pixabay License

On May 12, 2022, the price of a single BitCoin—the most popular form of the digital cash known as cryptocurrency—plunged to $26,293, from a high of $67,553 in November of the previous year. What did that mean? In the most basic terms, if you converted $100,000 of your bank account to BitCoin just six months earlier, you’d have only about $39,000 left to show for it. 

But that loss seems paltry in the context of the cryptocurrency collapse of 2022. In the single week leading up to May 12, investors in crypto lost a combined $600 billion. In the six months since BitCoin hit that all-time high, that and other cryptocurrencies (which largely collapsed at roughly the same rate as BitCoin) lost in the neighborhood of a trillion dollars in value. That’s more money than the Gross Domestic Product of all but 19 of the world’s 196 countries

The proclivity for rapidly inflating and collapsing is only one drawback of cryptocurrency. Due to its largely unregulated and decentralized system, crypto quickly became a favorite of drug and sex traffickers—a disturbing trend documented in a report by the United States government’s General Accounting Office. Federal prosecutors have singled out BitCoin as a primary currency funding the country’s opioid crisis. 

Terrorists are also big fans of crypto. In 2020, the U.S. Justice Department shut down cryptocurrency operations used by Al-Qaeda, ISIS, and the military wing of Hamas to finance their various terrorist activities. Fraudsters and con artists have adopted crypto as their own, as well. According to one study in January 2022, crypto accounts used for scams, Ponzi schemes, ransomware attacks and other illegal online rackets raked in $14 billion.

Cryptocurrency Goes Hollywood

The 2022 crash came on the heels of the moment when crypto appeared to finally be celebrated by mainstream culture, shaking off its shady image and going Hollywood. In December of 2021, the iconic Staples Center in Los Angeles—home to the NBA’s Lakers and Clippers, NHL’s Kings, and WNBA’s Sparks—changed its name to “Crypto.com Arena” after the Singapore-based app paid $700 million of presumably non-virtual money for 20 years of naming rights. 

Crypto.com and rival crypto exchange FTX also signed up a roster of A-list celebrities, including Matt Damon, Larry David, Lebron James and Tom Brady, to plug cryptocurrency in various TV commercials, several of which aired during the Super Bowl in 2022. Famous women such as Reese Witherspoon, Paris Hilton, Randi Zuckerberg (sister of Facebook’s Mark), and Gwyneth Paltrow actively endorsed crypto investment as a form of female empowerment.

When the New York Times contacted several of those celebs for comment on the financial disaster that had struck the very product they were pushing on the public, they all chose to keep quiet. But Jeff Schaeffer, director of the Super Bowl ad featuring David, confessed to the Times that both he and the Curb Your Enthusiasm comedian “have no idea how cryptocurrency works (even after having it explained to us repeatedly), don’t own it, and don’t follow its market.”

Which brings up some interesting questions—how does cryptocurrency work? Where did it come from, and why would people invest their money into a market whose value, or perceived value, fluctuates as wildly as crypto’s does? Cryptocurrency has seen its obituary written before—nearly 450 times in the media, according to a count by the site 99Bitcoins.com. After the crash of 2022, how much longer can it survive? 

What is Cryptocurrency?

Cryptocurrency, to put it as simply as possible, is cash that exists online—and nowhere else. What most of us know simply as “money,” is actually “fiat currency,” that is, cash issued and backed by a government. The U.S. dollar, for example, is minted in limited quantities by the American government, which backs the currency with its own “full faith and credit.” A dollar bill buys a dollar’s worth of stuff because that’s what the government says it does. As long as the U.S. government remains operational, a dollar is still a dollar and can be used to purchase anything you can buy for a dollar.

Cryptocurrency has the “full faith and credit” of no one, and nothing behind it. The value of crypto is determined solely by what crypto buyers are willing to pay for it. 

Similarly, you know that you own the money in your bank account because U.S. law says you do. How do you know that you own the money in your cryptocurrency account? All you have is a digital record—the “blockchain,” passionately believed to be bulletproof by crypto enthusiasts, but which at least in theory, could be erased or tampered with.

Even the purchasing power of crypto is not a measure of its value, because it isn’t used to purchase very much (at least not very much that's legal). The use of cryptocurrency as money for just buying stuff is negligible. At its peak in late 2021, BitCoin was used in 250,000 transactions per day

The only cryptocurrency used more often than BitCoin was Ether, which can be used only on its network, known as Ethereum. There were about 1.1 million Ethereum transactions per day in July of 2021. 

Credit cards are processed an average of 1.01 billion times every day around the world. 

Cryptocurrency serves primarily as a source of “stored value,” sort of a digital version of gold. No one uses gold for transactions, of course. But investors buy gold as a way to hold on to the value of money. Same with cryptocurrency. The question is—how well does crypto hold its value? If the crash of 2022 is any indication, not very well. 

The First Cryptocurrencies and the ‘Double Spend’ Problem

Cash that exists only online has historically had a big problem—one that the “crypto” in “cryptocurrency” tries to solve. Any digital data—text in a word processor, for example—can be easily, instantly copied. The music industry found this out the hard way when it began to digitize the music it sold, rather than imprinting it in grooves on solid vinyl platters. Suddenly, fans could quickly create perfect copies of any recorded music and share those copies for free with anyone, or even millions of people at once. 

Cryptocurrency is no different. A digital “coin” exists only as a chunk of data. So what stops anyone from copying the data and spending that same, copied coin again and again? That practice is known as “double spending,” and it’s basically counterfeiting, except much easier to do and  harder to stop than counterfeiting paper bills.

The answer to double spending is cryptography, the science of protecting information using codes. In the case of cryptocurrency, those codes come in the form of complicated algorithms and other mathematical formulas. Each unit of cryptocurrency, a BitCoin for example, comes with its own unique code, meaning that at least in theory that digital coin can be spent and received only by users who possess the correct code. 

BitCoin, while the most famous cryptocurrency, was not the first. The general idea had been kicking around in cyber-circles since the 1980s. In 1995 an American cryptography expert named David Chaum—who had first published a paper outlining the basics of online currency in 1983—came up with a system called DigiCash. The system was designed to let internet users make online payments in a secure and anonymous fashion. 

The online payments company also allowed users to make and receive payments in CyberBucks, the first online currency not issued or controlled by banks or any centralized institution. But by some accounts Chaum was not a great leader for the company. He departed after just a year, and DigiCash went bankrupt soon after.

Then in 2005, Bay Area-based cryptographer and political libertarian Nick Szabo published his idea for BitGold, a prototype for digital currency that could be traded anonymously and freely without interference, or backing, from a bank or government. Szabo’s idea relied on users solving complex cryptograms in order to get a “reward” paid in units of BitGold currency. In many important ways, Szabo’s BitGold anticipated what would soon become Bitcoin.

But Szabo could not come up with a solution to the double-spending problem. 

‘Satoshi Nakamoto’ Launches the Crypto Craze

On Halloween night, 2008, a nine-page white paper appeared on the Cryptography Mailing List, a messaging service run by and for cryptography enthusiasts, aka “cypherpunks.” The paper titled “Bitcoin: A Peer-to-Peer Electronic Cash System” was credited to someone using the name “Satoshi Nakamoto.” 

The person or group of persons using the pseudonym remains mysterious more than a decade later. The most common suspect named by amateur sleuths, including Elon Musk, is Szabo. But the BitGold creator has repeatedly denied that he is “Nakamoto.”

More important than the secret identity of the anonymous author is what the paper contained—a solution to the double spending problem using a blockchain, a way of verifying each transaction by securely recording it on a publicly viewable online ledger, but one secured by cryptography designed to prevent anyone from tampering with it. 

The blockchain does not exist on a single, central computer. Instead, it’s “distributed.” An exact copy exists on every computer on the blockchain’s network. When anyone anywhere uses Bitcoin for anything (or one of numerous other cryptocurrencies, some with their own blockchains, others using publicly available blockchain networks), that transaction is recorded within minutes on the blockchain ledger. The transaction is not final until it is recorded on the ledger.

It was Nakamoto who created the first “block” of BitCoin through a process known as “mining.” At the time—January 2009—mining BitCoin was pretty easy and quick, because the enigmatic Nakamoto was the only one doing it. That changed in a hurry.

What is Cryptocurrency Mining?

When Nakamoto mined the first Bitcoin, launching the cryptocurrency era, the “coins” were worthless. Very few people knew they existed, so no one was buying them. Nakamoto’s original block of 50 BitCoins, known to crypto users appropriately enough as the “Genesis Block,” was not even intended to be used in transactions.

Over the next few years, crypto—and Bitcoin specifically—began to catch on, gaining in demand and as a result, value. In February of 2011, the price of one Bitcoin reached $1 for the first time—meaning that a savvy investor who spent $1,000 on Bitcoin at that time and held on to it, would be sitting on about $30 million in May of 2022—even after the crash. 

The pivotal year for cryptocurrency came in 2013, when the price opened in January at $13, and climbed from there at a dizzying rate. By the time the year was out, the price of one Bitcoin hit $1,100. A $1,000 Bitcoin buy at the start of 2013 would be worth almost $87,000 by year’s end. 

Where was all of this crypto “coin” coming from? The process rather misleadingly labeled “mining” is not only how new Bitcoin is brought into being, but even more importantly, the way that transactions are verified and recorded on the blockchain, preventing double-spending and theoretically guaranteeing the integrity and honesty of every transaction.

Every new transaction is identified with a sequence of code known as a “hash.” Each hash contains a reference to the previous transaction added to the blockchain, which creates an unbroken sequence of hashes that lead back to the first transactions on the network. That way, every transaction can be determined to be authentic—but only by solving incredibly complex mathematical equations that unlock the longer code that identifies a particular transaction. 

The True Cost of Crypto Mining

When miners crack a code, they receive a payment, for example a brand new BitCoin. But while some cryptocurrencies have no limit to the number of coins that can be created, Bitcoin is capped at 21 million. As more coins are mined, they therefore grow scarcer and take even more effort to mine.

Mining cryptocurrency is head-spinningly complex and requires a vast amount of computing power to find solutions to its arcane coding puzzles. The electricity use alone is staggering. The power required to mine a single BitCoin, according to an analysis by PC Magazine, is enough to power the average American home for almost 79 days. With most electricity generated by burning fossil fuels, BitCoin (and other crypto) mining has become a significant contributor to climate change. BitCoin mining is estimated to spew about 37 million tons of carbon dioxide into the atmosphere every year, about the same as the entire country of New Zealand.

There are approximately one million BitCoin miners in the world, but according to a study by the National Bureau of Economic  Research just 50 of them control half of the total mining capacity, making the environmental cost of producing new cryptocurrency a high price to pay to for a small group of people to get very rich. 

The Great Crypto Crash of 2022

Cryptocurrency has always been volatile, to say the least. But over time the trend has shown gains in value, meaning that—at least until 2022—if crypto investors were willing to ride out the rollercoaster market and hold on to their digital coin for a period of years, they could turn a tidy profit. But in the six months following November of 2021, when the price of one Bitcoin peaked at an all-time high of $67,554, the cryptocurrency’s value collapsed. By late May of 2022, a Bitcoin was selling for $28,709—a crash of 57.5 percent. 

Imagine if you bought a house for, say, $1 million. Then just six months later you, for some reason, wanted to sell that house—only to find that it was now worth only $425,000. More than half of your investment simply vanished into thin air. You have two choices: bail and eat the lost money, or hold on to the house and pray that the real estate market makes a miraculous recovery. 

That’s the grim dilemma  that cryptocurrency investors found themselves facing in early 2022. What happened? Crypto has plunged before, but never like this. 

It’s worth remembering that crypto investment is not limited to online geeks and dubious wheeler-dealers. An entire country, El Salvador, under its increasingly authoritarian President Nayib Bukele, declared BitCoin a national currency (in addition to the U.S. dollar) in January 2022 after buying about $71 million worth of the cryptocurrency the previous September. 

The average price of BitCoin at that time, according to a Fortune Magazine report, was $51,056. If that report is accurate, the already debt-ridden country’s initial BitCoin investment was worth only $37 million by May 2022. 

The continuing crash did not deter Bukele. On May 9, 2022, he announced that “El Salvador just bought the dip,” an expression the refers to the purchase of an asset after its value drops in the expectation that it will soon rise again. Bukele said that his government had purchased “500 coins at an average USD price of ~$30,744.” In other words, El Salvador invested another $15,372,000 in the crashing cryptocurrency.

By May 20, 11 days later, El Salvador’s investment in “the dip” was worth $14,589,000—a loss of $783,000. 

Crypto’s attraction for public entities wasn’t limited to Latin America. Both New York City and Miami introduced their own cryptocurrencies in 2021. WIthin months, both went bust. MiamiCoin lost 92 percent of its value since hitting its peak in September 2021. NewYorkCityCoin fell 80 percent off its March 2022 high.

What Caused the Crypto Crash?

Perhaps the most significant problem with crypto is that, as Paul Krugman—a Nobel Prize-winning economist and New York Times columnist—stated, “cryptocurrencies play almost no role in economic transactions other than speculation in crypto markets themselves.” Outside of the relative anonymity that makes crypto the currency of choice for criminals and terrorists, there doesn’t seem to be much that can be accomplished with cryptocurrency that can’t be done more easily and reliably with conventional fintech apps such as PayPal, or with good old fashioned online banking.

According to Krugman’s analysis, unlike previous crypto crashes which eventually, sometimes hurriedly, reversed themselves, the 2022 collapse was less likely to turn around—thanks largely to the multiplying celebrity endorsements and mainstreaming of cryptocurrency. For the previous decade, crypto trading was confined mainly to a hard core of enthusiasts and true believers who were likely to stick with the crypto market out of pure faith, Krugman wrote.

The new Hollywoodification of crypto would seem likely to attract a flood of newbies who, having lost most of their money over the course of a few months, were more likely to jump off the bandwagon, making it harder for crypto demand to rebound.

Another reason why the value of crypto seems less likely to bounce back this time has to do with a type of cryptocurrency called “stablecoin.” As the name implies, stablecoin is designed to resist the volatility inherent in other cryptocurrencies by pegging its value to the dollar, or another relatively reliable asset such as gold. 

But in mid-May, as the plunge in crypto’s value continued unabated, two of the most widely used stablecoins—TerraUSD and Terra Luna—also crashed, something they were expressly designed not to do. Luna reached a low barely above zero. At the same time the cryptocurrency Tether—that single most popular stablecoin due to its consistent 1:1 value with the U.S. dollar—also fell, dropping as low as 95 cents.

Crypto Crash Takes a Human Toll

A New York Times report blamed the crash of Luna and its related currencies on hype created by the founder of Terra and Luna’s parent company, Terraform Labs. Do Kwon, just 30 years old and a graduate of Stanford University, was able to hyperinflate his currencies by cultivating a “cult of personality" around himself, leading to “irresponsible behavior” by the various financial institutions that backed his company, the Times reported.

The “stability” of Terra Luna is based on computer algorithms, rather than actual assets, as is the case with Tether. 

There appear to be other, more straightforward reasons behind the crypto crash. Economic uncertainty caused by inflation and a struggling stock market, the Ukraine war and the global political uncertainty it caused, and hikes in the interest rate imposed by the Federal Reserve Bank all helped to pull the rug out from under the crypto market, according to a Fortune analysis.

For the vast majority of investors, and just ordinary people, who have never put money into cryptocurrency, the crash may seem little more than a media spectacle. For those who have sunk considerable sums into the crypto market, the crash took a very real toll, financially and psychologically. The internet forum Reddit, where many crypto enthusiasts exchange ideas and tips, started to take a dark turn in May.

“I lost over 450k usd, I cannot pay the bank,” read one apparently typical post. “I will lose my home soon. I’ll become homeless. Suicide is the only way out for me.”

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