Is the cryptocurrency crash a threat to the financial system?
On Tuesday, bitcoin briefly fell below $30,000 for the first time in 10 months, while cryptocurrencies globally lost nearly $800 billion in market value over the past month, according to the data site. CoinMarketCap, as investors worry about monetary policy tightening. Compared to the last round of Fed tightening that began in 2016, crypto is a much larger market, raising concerns about its interconnectivity with the rest of the financial system.
HOW BIG IS THE CRYPTOCURRENCY MARKET?
In November, the most popular cryptocurrency, bitcoin, hit an all-time high of over $68,000, bringing the value of the crypto market to $3 trillion, according to CoinGecko. That figure was $1.51 trillion on Tuesday. Bitcoin accounts for almost $600 billion of that value, followed by Ethereum, with a market capitalization of $285 billion. Although cryptocurrencies have seen explosive growth, the market is still relatively small.
US stock markets, for example, are worth $49 trillion, while the Securities Industry and Financial Markets Association pegged the outstanding value of US bond markets at $52.9 trillion at the end of 2021. The cryptocurrency has started as a retail phenomenon, but institutional interest from stock exchanges, corporations, banks, hedge funds and mutual funds is growing rapidly.
Although it is difficult to obtain data on the ratio of retail investors to institutional investors in the crypto market, Coinbase, the world’s largest cryptocurrency exchange, said that institutional investors and retail each accounted for about 50% of its platform’s assets in the fourth quarter. Its institutional clients traded $1.14 trillion in crypto in 2021, compared to just $120 billion in 2020, Coinbase said.
Most bitcoin and ethereum in circulation are held by a select few. An October report from the National Bureau of Economic Research (NBER) found that 10,000 bitcoin investors, individuals and entities, control about one-third of the bitcoin market, and 1,000 investors own about 3 million bitcoin tokens. About 14% of Americans were invested in digital assets in 2021, according to a University of Chicago study. COULD A CRYPTO CRASH HARM THE FINANCIAL SYSTEM?
While the overall crypto market is relatively small, the US Federal Reserve, the Treasury Department and the International Financial Stability Board have flagged stablecoins – digital tokens pegged to the value of traditional assets – as a potential threat to the financial stability. Stablecoins are primarily used to facilitate trading of other digital assets. They are backed by assets that can lose value or become illiquid in times of market stress, while the rules and information regarding these assets and investors’ redemption rights are murky.
This could make stablecoins susceptible to losing investor confidence, especially during times of market stress, regulators said. This happened on Monday, when TerraUSD, a major stablecoin, broke its 1:1 peg to the dollar and fell as low as $0.67, according to CoinGecko. This decision partly contributed to the fall of bitcoin.
Although TerraUSD maintains its link to the dollar through an algorithm, investors using stablecoins that hold reserves in assets such as cash or treasury notes could spill over into the traditional financial system, causing stress in these classes. of underlying assets, according to regulators.
With more corporate fortunes tied to the performance of crypto assets and traditional financial institutions meddling more in the asset class, other risks are emerging, regulators say. In March, for example, the Acting Comptroller of the Currency warned that banks could be trapped by crypto derivatives and unhedged crypto exposures, given that they are working with little historical price data.
Yet, overall, regulators are divided on the extent of the threat a crypto crash poses to the financial system and economy at large.