With inflation at historic highs and the Fed raising interest rates as a result, risk assets are taking a hit, and crypto markets have been crashing for months.
But economist Mohamed El-Erian says that’s just part of a new technology finding its footing.
“Crypto is going through what most innovations go through,” El-Erian, chief economic adviser at financial services firm Allianz and president of Queens’ College at Cambridge, said on a Yahoo Finance livestream last week.
El-Erian says crypto is currently in “round one” of its development, characterized by overproduction and overconsumption. That happens because “you suddenly lower the barriers to entry to a certain activity,” he said.
“We saw lots of people coming in who didn’t quite understand what that crypto space really is,” said El-Erian. “They just saw prices going up and thought they would go forever, so we had a massive speculative demand.”
Things are changing now, according to El-Erian. “We’re washing all that out,” he said. “You’re washing right out the supply side and the demand side. And the hope is that you reestablish a stronger foundation, as tends to happen with innovations.”
El-Erian added that the pattern he’s observing with crypto has played out time and time again with new innovations. “That happened during the steam engine. It happened during fiber optics. It happened even during synchronization into 2000,” he said. “The first round isn’t particularly good.”
In May, TerraUSD, an algorithmic stablecoin, collapsed along with its sister currency, Luna. Then in June, crypto lender Celsius froze billions in assets as investors rushed to make withdrawals. Babel Finance, another crypto lender, also recently paused withdrawals, and Three Arrows Capital, a crypto hedge fund, is facing liquidity issues.
Earlier this month, Bitcoin fell to below $20,000 for the first time since December 2020, though it has since stabilized and risen above that mark again. At the same time, Ether, the second-largest cryptocurrency, fell to below $1,000—its lowest price since January 2021.
Several crypto companies have had to make major staffing cuts because of the downturn. Coinbase saw its shareholder value drop as it laid off 1,000 employees in June.
It’s unclear how long the current period of destabilization will persist, with some crypto leaders predicting a coming “crypto winter.”
“In past crypto winters, trading revenue (our largest revenue source) has declined significantly,” wrote Coinbase CEO Brian Armstrong in a blog post announcing layoffs at his company on June 14. “While it’s hard to predict the economy or the markets, we always plan for the worst so we can operate the business through any environment.”
El-Erian is not the only major figure who believes that the crash will result in better technologies and a more stable industry in the long term.
“In stocks and crypto, you will see companies that were sustained by cheap, easy money—but didn’t have valid business prospects—will disappear,” Mark Cuban told Fortune earlier this month. “Disruptive applications and technology released during a bear market, whether stocks or crypto or any business, will always find a market and succeed.”
The reckoning that crypto is now facing is just one part of a larger economic paradigm shift, according to El-Erian. “It’s about time we exit this artificial world of predictable massive liquidity injections, where everybody gets used to zero interest rates, where we do silly things where there is investing in parts of the market we shouldn’t be investing in, or investing in the economy in ways that don’t make sense,” he said on CNBC’s Squawk Box earlier this month.
“We are exiting that regime, and it’s going to be bumpy.”
