Crypto’s Native Features Didn’t Cause the Crash – Financial Illiteracy Did

Originally published JUN 15, 2022 in Nasdaq. By Jarek Hirniak, founder and CEO, Generation Lambda

An investor walks into a bank and tells their broker to put their life savings into one stock they saw trending online. The broker, having both fiduciary duty and common sense, tells them this is risky at best and wildly irresponsible at worst. Outside the bank, a crypto trader downloads a wallet and dumps their life savings into a coin that's going "to the moon" according to Reddit. No one blinks an eye. In fact, when they post about it, they’re met with encouragement.

Crypto enthusiasts and Bitcoin (BTC) devotees continue to excuse themselves from the basic responsibility of understanding how money works. Because so many crypto traders have embraced the winner-take-all mentality, there is a nasty precedent for reckless decision-making that has normalized financial irresponsibility within crypto markets. By treating crypto investments like gambling, traders prevent decentralized finance from functioning as a true currency. Those who fashion themselves as financial renegades are the ones ruining crypto’s opportunity.

Coin holders have a responsibility to understand financial markets and tokenomics

One of the major problems is that crypto is considered separate from traditional finance in function, which means participation in crypto doesn’t facilitate or encourage an understanding of the basics of finance. When everyone expects a much-hyped coin will explode in value far beyond the reasonable expectations of traditional stocks, reasonable investment practices go out the window.

Cryptocurrency communities and knowledge bases exist entirely online and congregate around unvetted influencers across sites like Reddit and TikTok. This fosters an anonymous, accountability-free, meme-based dissemination of information beholden to hype and popularity rather than financial productivity. When asset marketing becomes a popularity contest, crypto projects are not judged by their inherent value or the soundness of their technology. Yes, tokenomics are complicated, but any investor playing the game ought to know the rules. In fact, for the sake of everyone playing, please learn the rules.

YouTubers and TikTokers make money by measuring the number of eyeballs they get for their content. They monetize views. They are not brokers, they are entertainers. Their industry is digital content, not finance. Whether or not their financial advice is useful or terrible is immaterial to their bottom lines. Why, then, are they treated like brokers? Smart investors vet potential financial advisors’ training, professional relationships, and history – not view counts.

Crypto operates like a Ponzi scheme because investors treat it like one

In the spring and summer of 2021, the NYSE was caught off-guard when a number of “meme-stocks” rocked the market. The initial assessment for the short squeeze on GameStop (GME) was correct, however, it quickly devolved into something unhealthy based on the greater fool theory. It stopped being driven by financially reasonable investment practices and transformed into a call to action that spread into other stocks like AMC and Hertz. These stocks saw massive gains, despite their primary business profitability taking a dive during the pandemic. This led seasoned traders to wonder if younger investors were just using the stock market as a new form of gambling and caused apps like Robinhood to halt trading for periods of time. Financial publications considered it a distraction from the reality of the stock market as a financial tool for investors and public companies. Why had Redditors poured money into stocks of companies that were not outwardly profitable, and more importantly, why had it caught the entirety of Wall Street on its back foot? Because there was no concrete financial reason to invest in these stocks, and the arbitrary nature caused a jolt to the entire system. 

This moment of reckless, outsider, big-risk-style trading made serious waves, and it, unfortunately, cemented the perception of the DeFi and crypto spaces as reckless, ill-informed, and wildly risky. Investors will go all-in on a token without a true understanding of its utility, the project’s tokenomics, or the likelihood of its longevity or success. This trading style and pump-and-dump overload played a major part in the crypto crash. It is this lack of due diligence that caused so many crypto investors to back LUNA after influencer Raoul Pal claimed it would provide a 20% return “basically risk-free.”

Anyone with a passing knowledge of finance knows a statement like that is pure fantasy. Riskless 20% APY means that $1,000 put down today guarantees $1M in 35 years via continuously compounded interest. If this is available to everyone, where will this extra $990,000 come from over 35 years? Is the protocol able to generate that much value to provide such revenue for potentially everyone on the planet? Anyone who believed the initial claim was delusional, and that negligence ended up crippling decentralized finance.

Scrolling through the top 500 crypto projects by market capitalization on CoinMarketCap reveals a market in conflict. The list is full of plenty of ambitious projects that can positively contribute to and solve real-world challenges. These are projects like CardanoArWeaveMina, and Ergo. They’re woven in between projects that offer nothing new. These projects are a copy of existing coin contracts with a small parameter change, such as Shiba Inu, Shiba Floki Inu, SafeMoon, Million Token, and so on. These projects are simple Solidity contracts that require no technical expertise. They provide no real-world value and are focused exclusively on marketing. It reveals how financially immature those investing in cryptocurrencies are. What’s insane is that some people fully understand the lack of any fundamentals in those projects, but bet that there will be enough hype-based interest to buy into the token for the price to rise. 

Investors have a responsibility to understand their own finances

Crypto investors need to take responsibility for their own financial literacy. It is not just unwise to blindly choose crypto investments without understanding them, it’s risking the already shaky legitimacy of the crypto sphere itself. Some investors will always treat both the stock market and the crypto sphere (or both) as casinos, but the legitimacy and value of the stock market are able to withstand that treatment in a way the crypto sphere simply cannot.

The crypto market skews younger, and these investors are often participating via traditional platforms like Robinhood. They tend to focus more than the previous generations on the social standing of certain projects, both in terms of what their friends invested in and what is popular among peers. This is an interesting approach that has led to “social investing,” which some platforms now offer as a feature. But this hive-mind investment trend allows new investors to fall into the trap of copying what’s popular, which is precisely how scam projects exploit investors via aggressive marketing. Investors getting into crypto must learn how to identify these schemes. 

This crash has put crypto on the defensive, and mitigating the damage begins with remedying the financial illiteracy and ill-advised risk-taking that not only brought it to the brink but took it right over the edge. Getting it back on its feet will require taking some responsibility for ourselves, en masse.

About the author:

Jarek Hirniak is the founder and CEO of Generation Lambda. Jarek is a certified quant with over 20 years of software development experience, including over eight years of leading large-scale teams. Jarek spent six years working on trading systems at Citadel Securities (the largest market maker by volume in the world) and UBS bank (the world leader in non-systematic trading and investing). He developed a series of novel trading systems and trading-related software platforms while leading multi-disciplinary teams. His work developing revolutionary software and researching trading strategies now facilitates multi-billion dollar (USD) daily trade volumes. He believes that decentralized finance and people power can take on the traditional system that has historically only favored a few. By taking control of the chaos using formal methods and advanced mathematics, Jarek and the team at Generation Lamda want to help billions achieve their financial sovereignty through decentralized finance and launch finance into a new era of verifiable security, sound financial markets, and complete transparency.