This analysis was first published in SvD Näringsliv, in Swedish, on May 13th, 2022. This piece was translated from Swedish by Claude. Some phrasing may differ from a human translation.

An attack on a cryptocurrency has wiped out hundreds of billions of kronor — almost overnight. The crash lays bare the financial risks that cryptocurrencies were supposed to prevent. Now a crypto crash could send serious waves through the rest of the market.

Have you heard of stablecoins? As the name implies, the idea is that stablecoins should bring stability to cryptocurrency markets — markets that are often viewed as highly volatile.

The idea is easy to grasp. You exchange a dollar for a stablecoin, and then use that to more easily trade other cryptocurrencies. The value is guaranteed by the money you swapped them for to begin with. Simple! At least in theory.

The problem is that these stablecoins are not always as stable as they first appear. Over the past few days, a stablecoin called TerraUSD — and the cryptocurrency Luna that was directly tied to it — have fallen 73 and 99 percent respectively. Hundreds of billions of kronor in market value have gone up in smoke on those two alone. And other stablecoins that have been heavily questioned before, like Tether, have wobbled too.

TerraUSD was a so-called algorithmic stablecoin. It lacked a 1:1 link to a conventional currency, but via financial algorithms the price was meant to tie TerraUSD to Luna so that the value always stayed constant. If one went up, the other was supposed to follow.

What triggered the fall appears to have been a very complex and sophisticated attack. The attacker understood the technical limitations well, and had a billion dollars to play with in order to pull it off. Through a series of technical manoeuvres and the use of derivatives, they managed to sink an entire ecosystem — and profit handsomely in the process. Rumours spread quickly that the hedge fund Citadel Securities and Blackrock were behind the attack, something both have strongly denied.

The timing is, to put it mildly, poor. Cryptocurrencies have broadly plunged in value recently, as the market has sought out safer asset classes.

It would be easy to dismiss what has happened as an internal matter for those speculating in cryptocurrencies — the ones who play the game ought to cope with the consequences.

But there is something familiar about how this played out. Advanced financial products that the ordinary retail investor can’t reasonably understand or trade in have sunk an entire industry before — and dragged everyone down with them.

The financial crisis of 2008 was also shaped by complex derivatives and asset classes. The fallout hit far more people than those who knew, or traded, the so-called credit default swaps and collateralised debt obligations. That was where the problems began — and they ended with mass layoffs in the largest global financial crisis in modern times.

Cryptocurrencies may have crossed over into the broader financial market. As Bloomberg columnist Matt Levine puts it: “If you had asked regular people two weeks ago how their lives would be affected if the price of some digital pictures of apes and algorithmic stablecoins crashed, I think most of them would have said it wouldn’t affect them at all.” A reasonable answer, of course. But it is probably no longer that simple.

An exchange-traded fund in Switzerland, tied to the Luna mentioned above, fell 99 percent on Thursday. It was available to buy on ordinary trading venues.

The situation today is that bitcoin is traded on purpose-built, entirely regulated exchanges, but also indirectly through its own exchange-traded funds. On top of that there are specific listed companies whose only business is to hold bitcoin. And in addition to all this, there are private individuals and institutions that have taken out loans to buy cryptocurrency, and that sometimes use cryptocurrency as collateral to buy more.

All of these actors are part of the broader financial market. Should the market for cryptocurrencies crash altogether, it could send ripples far beyond the traders themselves.