How is the crash of crypto *brokerage houses* and lenders likely to affect the broader economy?

You may have heard that the price of "cryptocurrency" has been falling.  The article below is a careful Narrative to soothe investors.  At the end I'll tell you what I think this means for the economy and the future.

Article from crypto-following website "CoinDesk," June 29, 2022
 
Cryptocurrency market maker and lending firm Genesis Trading is facing potential losses into the “hundreds of millions.”  The DCG-owned trading colosus is said to have suffered losses in the hundreds of millions.

The losses at Genesis relate, in part, to exposure to over-leveraged hedge fund Three Arrows Capital and Hong Kong-based crypto lender Babel Finance, and are on the order of “a few hundred million dollars.”

The losses come as the collapse of Three Arrows Capital sends shockwaves across the crypto lending industry, with numerous firms facing substantial losses from their exposure to the fund.

The precise tally of Genesis’s losses may not be known for some time because the company is seeking at least partial repayment from its counterparties and some of the losses may have been offset by hedging.  Amid such uncertainty, Genesis has been pulling credit lines from counterparties.

Genesis, which is owned by Digital Currency Group (DCG), also the owner of CoinDesk, issued the following statement from CEO Michael Moro:
[Wait...you say the website writing this story is owned by...the same holding company that owns the company that's looking at losses of "a few hundred million dollars"?  Um...do we expect the truth here, or a soothing "Don't worry, citizen!  In fact this is a GREAT time to buy crypto!" kind of story?]

"As we already stated on June 17, we mitigated our losses with a large counterparty who failed to meet a margin call to us. We sold collateral, hedged our downside and moved on. Our business continues to operate normally and we are meeting all of our clients' needs."

[Wait again: "who failed to meet a margin call TO us"?  If you're the lender, wouldn't that be YOU making the margin call to the borrower--in this case to Three Arrows Capital and others?  Perhaps I'm confused.]

A cascade of liquidations at many different crypto lending and trading platforms has followed the high-profile unraveling of crypto firms such as Terraform Labs (of Terra and luna infamy), Celsius and Three Arrows Capital, aided by a plunge in the value of cryptocurrencies across the board.

The impact from Three Arrows Capital in particular has been felt widely. Crypto brokerage Voyager saw its stock plunge and was forced to limit withdrawals as it declared the hedge fund in default on loans worth around $670 million. Others, including BlockFi, are believed to be facing similar *challenges.*

["Challenges" is apparently a euphemism for "losses," but far less scary to potential investors.]

Genesis has previously acknowledged taking a hit in the bear market. The firm “carefully and thoughtfully mitigated our losses with a large counterparty who failed to meet a margin call to us,” CEO Moro tweeted in mid-June.

[There's that "margin call TO us" again, from the same CEO.  But as I understood it, Genesis had allowed its investors to buy crypto "on margin"--i.e. by borrowing the needed funds from Genesis.  As with stocks bought on margin, the collateral for the loan was the investor's crypto holdings.  When the value of those holdings collapsed, the lender would make a "margin call" TO the borrower/investor, not the other way round.  Something amiss here, and it could be me.]
   [Ah, we get more clues in the next 'graf:]

Genesis originated over $44.3 billion in loans in the first quarter of 2022. Its parent company, DCG, a large crypto conglomerate rumored to have a war chest of about $1 billion, is likely to help Genesis “buffer that shock,” a source said.

Other crypto lenders have enlisted deep-pocketed saviors in recent days, with FTX’s Sam Bankman-Fried making opportunistic investments in BlockFi and Voyager.

Forced deleveraging across markets has further tanked bitcoin’s (BTC) price in recent days with the leading cryptocurrency currently trading at around $20,000.

["Forced deleveraging" is probably not a familiar term to laymen.  Buying *stocks* on margin is called "leveraging," so the same term is likely used for investors who buying crypto with borrowed funds.  So "deleveraging" would be selling the collateral if a borrower/investor couldn't meet a margin call to the borrower, which would be triggered by the collapse of crypto prices.]
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Now, if you're not into cryptocurrency you probably think the events carefully described above aren't relevant to the rest of us.  I hope you're right, but...here's what I think is happening, and what it portends for the economy and for those of us NOT in crypto:  

To understand this, you need to review the stock market crash of October, 1929.  As the U.S. economy boomed after the end of WW1--in part because Europe had been devastated by the war--U.S. stocks also boomed.  Farmers and shopkeepers and small-business owners who knew virtually nothing about the market read stories about investors making huge profits in stocks, and jumped in--which pushed the market even higher.

Wall Street insiders knew they could make several times more profit by buying stocks "on margin"--i.e. by borrowing the funds from the brokerage houses, using their holdings as collateral for the loan.

As long as the value of stocks either kept rising or at least didn't fall, everything was fine.  But if stocks fell (which no one believed could happen), so that the value of a borrower's portfolio no longer covered the loan, it would trigger a "margin call," in which the broker/lender would tell the borrower he had to put up cash or more collateral within X days or the brokerage house would sell his stock to repay the loan.

Even a Democrat can see what would happen if stocks faltered: thousands of investors would be unable to meet the lender's margin calls, meaning the brokerage would sell their stocks.  But can anyone guess what a wave of sell orders would do to stock prices?

Your Secretary of the Treasure, Janet Yellen, claims not to know, since she denies any relationship between supply, demand and prices.  But you know:  Stock prices would fall.  And what would THAT do?

You know that too: it would trigger MORE margin calls.  Which would...you get it:  Lather, rinse, repeat.

(In engineering and aerodynamics and economics that's called "positive feedback," when a small change from equilibrium triggers more change in the same direction.  But to laymen that term sounds good, when in reality it's very bad, so writers have stopped using that term.  Go figure.)

When crypto was going up, up, up, all the cool kids got in on the game.  Which pushed prices even higher, causing more cool kids to get in.  And the crypto brokerages were happy to loan money to those investors to let them buy MORE crypto on margin.

When crypto prices faltered, the brokerages issued margin calls.  When the cook kidz couldn't meet those margin calls, the brokerages liquidated their accounts (sold their crypto that was pledged as collateral for the loans).  Which had the exact same effect as margin calls way back in 1929.  

So the question now is, how much effect will this have on the economy?

Once again the experience of 1929 may be instructive.  Stocks had been booming--up ten-fold in nine years.  Brokerage houses were loaning investors up to two-thirds of the value of stocks they bought ("margin or leverage").

On March 25, 1929, after the Federal Reserve warned of excessive speculation, a small crash occurred as investors started selling more stock than usual, exposing the market's shaky foundation. Two days later National City Bank announced it would offer $25 million in credit (i.e. loans) to stop the slide.

It worked, and call money (the dollar value of stocks bought with borrowed money compared to total stock value) declined from 20 to 8 percent.  However, the American economy showed ominous signs of trouble.  Steel production and car sales declined, construction was sluggish and consumer debt was rising because of easy credit.

Despite another market selloff in May 1929, stocks resumed their advance in June.  The Dow Jones industrial average had risen ten-fold in just nine years, and between June and September alone the Dow rose more than 20%.  (Compare this to crypto's rise.)

By August brokers were routinely loaning small investors more than two-thirds of the face value of the stocks they were buying.  Uh...is that relevant, something we should worry about?  Well, turns out the total of money loaned to investors by brokerage houses to buy stocks ("margin") was *more than the entire amount of currency circulating in the United States at the time.*  Hmmm...

On September 8 financial expert Roger Babson predicted that a crash was likely and could be severe. The initial September decline was thus called the "Babson Break" in the press, but many investors regarded the "Break" as simply a "healthy correction" and a great buying opportunity.

On September 20, 1929, the London Stock Exchange crashed when a major British investor many of his associates were jailed for fraud and forgery.  That crash is thought to have shaken the confidence of investors in the U.S.  Periods of selling and high volumes on the U.S. market followed, followed by brief periods of rising prices and recovery.

Three weeks later selling intensified.  On October 24--later dubbed "Black Thursday"--the market dropped 11% at the opening bell on very heavy trading.  This led several prominent Wall Street bankers to meet to try to stop the selling.  The bankers chose Richard Whitney, vice president of the Exchange, to act on their behalf.

With the bankers' financial resources behind him, Whitney placed an order to buy 25,000 shares of U.S. Steel at $205 per share--a price well above the current market, and placed similar above-market buy orders on other blue-chip stocks.  

The tactic worked: After dropping 11% on opening, the Dow Jones average closed that Thursday down only two percent.

Four days later, on October 28 (later dubbed "Black Monday") the slide continued with the Dow falling almost 13%.  The drop triggered margin calls to investors, which many couldn't meet, which caused their brokerage houses to sell their portfolios, putting further downward pressure on prices.

The next day--October 29 ("Black Tuesday") "panic selling" reached its peak, with some stocks having no buyers at any price. The Dow lost almost 12%.  So in four trading days the Dow lost about a quarter of its value.

But the next day (October 30), with prices low, many buyers returned, convinced recovery was on the way, sending the Dow back up by 12.34%, to close at 258.  Yay, crash over, right?  And indeed, by April of 1930 the Dow had recovered to 294 before entering a much longer slide.  
On July 8th, 1932 it bottomed at 41--a drop of 85% or so from the 380 the index reached before the crash started.  Ultimately some 4,000 banks and other lenders failed.

The Dow would not return to its peak close (September 3, 1929) for 25 years (November 23, 1954).

The big question is, why did the market keep falling for 32 months after the initial drop, despite the price-supporting interventions of major banks and investors to halt the slide?

That question has prompted thousands of books, and many theories.  The one most often cited is that because the crash in stock prices wiped out a huge number of small investors, those consumers were then forced to cut their "normal" spending.  

Also, given the long bull market many small investors invested their savings in leveraged investment funds like Goldman Sachs's "Blue Ridge trust" and "Shenandoah trust."  The crash wiped these funds out, resulting in losses "to banks" equal to $590.25 *Billion* in 2021 dollars.  (Wiki doesn't give a figure for the millions lost by the small investors.  Hmmm...)

With consumers losing everything and businesses failing, the demand for primary industrial products like steel also collapsed.  With much lower demand, more companies went bankrupt, and the ripples just kept spreading.

So, returning to the present, let's look at what aspects the crypto crash are different, and what are the same as 1929.  Certainly the boom in crypto prices mirrors the huge rise in stocks in 1929, as does the huge rise in the number of people jumping into that market.

But the real landmine is the vast amount of crypto bought on margin--something that certainly exacerbated the 1929 crash.  I think we're looking at a domino effect, which the big crypto firms and lenders will blame on isolated fraud.  And I don't doubt any investigation will show there was a lot of fraud:  lots of scam artists want to be "cool kidz," and if cutting a few corners will win $100 million dollars...

Fortunately, unlike most businesses, crypto produces nothing, so the collapse of dozens or hundreds or thousands of the reported 19,000 crypto "coins" won't lose any productive capacity.  Even a few billion dollars in erased value doesn't actually impact the economy, since the money investors paid for crypto are simply transferred from investor to scammer.

But even though, as outlined above, the crypto crash doesn't cause direct losses, it's likely to have negative indirect effects such as reduction in spending by investors who lost (or will lose) a big percentage of their paper wealth.  

Now for the wild-card: The biggest companies in crypto lending and brokerages have assets in the billion-dollar class.  It doesn't take a genius to predict that the people who own those firms will try to get the biden regime to cover their losses.  Of course there is no legal or Constitutional authority for this, but they *will* try.  And with so much money at stake they can afford to bribe regime lackeys and the entire congress.  So we're going to be hearing about efforts to "socialize" the losses soon.

"A" source--flaky but good starting point.

https://en.wikipedia.org/wiki/Wall_Street_Crash_of_1929#Crash