Terra, Celsius, and lessons from the 2008 financial crisis

May and June 2022 were two of the worst months for the cryptocurrency markets since the 2018 crypto winter. First, Terra’s algorithmic stablecoin, UST, collapsed, wiping away billions of dollars from cryptocurrency investors worldwide. Then, one of the leading crypto lenders, Celsius, suffered a complete collapse of liquidity and locked two million investors out of their tokens.

Those of us who have spent the last few years building and investing in this industry have seen significant failures like this before. But consumers shouldn’t have to face these problems because it’s not how blockchain was designed.

When theoriginal Bitcoin whitepaper was written in the wake of the 2008 financial crisis, it described a Bitcoin blockchain designed for each person to control their assets with perfect transparency. The purpose was to prevent double-spending and ultimately remove the middlemen who had lost the trust of the very people they were supposed to be helping.

Satoshi Nakomoto, the anonymous creator of that infamous Bitcoin whitepaper, detailed that each token is to be held by one wallet at a time, removing the possibility of leverage to create deeper problems. Unfortunately, companies like Terra, Celsius, and numerous others put an opaque layer of financing on top of a transparent system, allowing double-spending (also known as double hypothecation), partial capitalization, and dangerous amounts of leverage.

All three of these issues can magnify losses by multiplying the risk being taken with a given amount of capital. Under-capitalized, over-leveraged investment banks created a $15 trillion loss during the financial crisis—despite having a tiny fraction of that much capital at risk.

A better approach than the centralized one taken by Celsius allows users to control their own assets. Known as “non-custodial,” such solutions allow people to own their private keys and take control of their own finances. This way, they always control their cryptocurrency and non-fungible tokens (NFTs).

As we learned from the 2008 financial crisis, it is necessary to have a decentralized approach to financial systems that puts people first. We can also learn three good lessons from today’s most recent disasters.

1. Algorithmic stablecoins aren’t possible.

UST, unlike USDC, wasn’t backed by US dollar reserves, so Terra couldn’t pay out in a tough market. Make sure your stablecoins are backed by cash reserves, and avoid stablecoins that are backed by a basket of cryptocurrencies.

2. Use non-custodial wallets.

If you trust centralized players like Celsius with your assets, then you may not be able to get your money out in a crisis. The very nature of Celsius—and other well-known custodial wallets—control the user’s private keys, meaning a third party has full control over your funds.

3. Leverage and margin trading are for professionals only. 

Even in a crisis like this, BTC has dropped roughly 50% since the beginning of the year, which means everyone holding real BTC in real wallets still has half their money. If you were using 10:1 leverage, then you would have lost all of your money by January 20 of this year.

These lessons were the exact same lessons Wall Street should have learned from the 2008 housing crisis. The Mortgage-Backed Securities were supposed to make something stable from a basket of assets that were all correlated—just like algorithmic stablecoins. Investment banks like Lehman Brothers were leveraging the money of their investors to make even more money—just like Celsius. This type of leverage can turn a moderate downturn into a massive crisis.

In 2008, individuals were taking on more mortgage debt than they could afford because they believed the real estate market would always go up. In early 2022, crypto investors were holding seemingly safe and stable investments that disguised risky bets beneath them.

In both cases, innocent people have paid the price for companies acting recklessly with other people’s money— and for the sophisticated investors who used their credibility and capital to bring millions of consumers into investments they didn’t fully understand.

But the ultimate rule for investors to remember is Warren Buffett’s classic advice, “Be fearful when others are greedy, and greedy when others are fearful.”

Marc Blinder, founder & CEO at AIKON and core contributor to the ORE Blockchain.