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Is Crypto the New Subprime? Crash Hits Mainstream Investors Hard

The crypto crash sparks comparisons to the subprime mortgage collapse, but some economists and analysts don't see it that way.
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Yogi Berra, baseball legend and malaprop master, was once quoted as saying "it's like deja vu all over again."

The recent cryptocurrency crash that has wiped out more than $1.2 trillion in value is drawing sparking comparisons in some circles to the subprime mortgage crisis of the early 2000s, which ignited the worst economic crisis since the Great Depression.

"I'm seeing uncomfortable parallels with the subprime crisis of the 2000s," Nobel prize-winning economist Paul Krugman wrote in an opinion piece published in the New York Times.

"No, crypto doesn't threaten the financial system- the numbers aren't big enough to do that," he added. "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."

'I Considered Suicide'

The people who are approved for subprime mortgages historically have low credit scores and problems with debt and minorities were far more likely to receive a subprime loan than white applicants. 

Two-fifths of crypto traders are not white, according to a survey conducted last year by the National Opinion Research Center at the University of Chicago.

In addition, the survey found that the average cryptocurrency trader is under 40 and does not have a college degree, 41% are women, and over one-third have household incomes under $60,000 a year.

And there are  some scary crypto wipe-out stories to be found on social media, such as the person on Reddit who talked about losing "90% of my net worth ($400K) on crypto."

"I considered suicide, lost weight, lost my passion for my hobbies, eating, sleeping etc," the poster said. "The depression/stress I had, combined with all the money I had, really made me reach rock bottom in my life."

So are we setting up for another meltdown? Well, Yogi Berra also said "the future ain't what it used to be," and some analysts feel the same way.

Gregory Price, economics professor at the University of New Orleans, noted that the collapse in subprime mortgages caused economic distress due to “deleveraging” as financial firms and households had to sell assets to cover losses from debt finance.

'Adequate Due Diligence'

This caused a downward spiral in asset prices overall, putting recessionary pressures on the overall economy.

"Subprime mortgages could be used as collateral for other asset purchases as well, and this is not true for cryptocurrencies," he said. "As far as I know, there are no formal markets for the debt-financing of cryptocurrency purchases. Thus, a collapse in cryptocurrency prices is not likely to have the same catastrophic effects as the collapse in subprime mortgages."

During the subprime mortgage collapse, Page added, "the disproportionate exposure of minorities led to disproportionate deleveraging." 

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"As cryptocurrencies are not debt-financed, the deleveraging effects will likely be absent," he said.

Mychal Campos, head of investing at Betterment, said the subprime comparison is justified to a certain extent, noting that "some of the products that have emerged for decentralized finance (DeFi) blockchains give me the eerie deja vu of experiencing 2007-2008 all over again."

"When you can lend and earn yields based on specific blockchain protocols in DeFi that are so far beyond what the actual interest rate market will offer at this point, you can't help but feel that we're in 'tulip mania' territory," he said, referring to a period in the Dutch Golden Age when tulip prices soared.

He added that it should not be a surprise to anyone that crypto has "become part of the story in terms of the overall frothiness in the pricing of risky assets."

"Crypto is here to stay, but crypto valuations were going to come down to earth at some point," he said.

"Subprime assets were heavily regulated," said Beth Haddock, legal advisor with Balancer Labs. "The financial institutions handling those failed to due adequate due diligence regarding the risks of the underlying assets in wrapped securities."

Crypto risks are more well-known and accepted by those individuals who invest, she added.

"The more valuable discussion is how we can make sure players aren't accepting unreasonable risks for their own circumstances," Haddock said.

 Moral Hazard

Brad Harrison, CEO of Venus Protocol, said the subprime crisis was "fueled by borrowers who had no clue that the interest rates on their loans were going to slap them into foreclosure."

"In decentralized finance every borrower should see very clearly at what level their loans gets 'foreclosed' or liquidated by the protocol because these ratios are published in the apps," he said. "What's more, all these loans are over-collateralized, without being repackaged into other products, so the risk is limited by the market's ability to recoup which is all automated. It's a far more capitally efficient process."

Jared Diamond, vice president of business development at Balancer Labs, said the subprime crisis is the result of "moral hazard and accountability within our financial system."

"The reason why this impacted the average customer is because they were targeted by the intermediaries of the financial system," he said. These intermediaries were incentivized to quickly originate loans regardless of the borrowers ability to repay and quickly sell those loans to larger banks for repackaging into transfer vehicles."

Diamond added that "no institution is move fiercely pushing crypto on the average retail customer."

"Banks pushed loans on the average homeowner selling the dream when there was no way they could ever pay it back," he said. "Crypto was not controlled by institution and as such there is room for creative incentive alignment. This is an ongoing experiment in DeFi."