The unexpected shutdown of crypto platforms owing to fraud and cyber-attacks, together with the precipitous decline in cryptocurrency value (nearly 50% since the beginning of 2022), does not bode well for the future of these digital currencies. However, the crisis provides a chance to look more closely at the market’s foundational problems, address regulatory concerns, and restore trust among all parties involved.
As central banks continue to hike interest rates, cryptocurrency values have plummeted, leaving many to speculate on whether or not this is the beginning of the end of the bubble. Probably not just now, anyhow. Values of assets whose primary use is in the future are more sensitive to increases in the opportunity cost of money. Cryptocurrencies were helped by the historically low interest rate environment, and youthful investors are now feeling the pain of a typical interest rate hike.
Bitcoin appealed to many as an inflationary hedge owing to its low (near zero) correlation with conventional assets such as equities before the epidemic.
Crypto investors are aware that this uncorrelation has been noticeably absent in 2022. Stocks and bonds have been falling due to inflation worries and geopolitical concerns, and cryptocurrencies have been following suit.
It was noted that “the narrative has made a 180° swing, due to macroeconomics adjustments,” which meant that the previous statements were no longer accurate. The correlation between Bitcoin and the S&P 500 hit a record high of 0.69, as reported by 21Shares. This created doubt about crypto assets’ value as a portfolio diversifier.
Crypto Crisis and Financial Markets
Before the epidemic, there was little to no relationship between Bitcoin and Ether and the main market indexes. They were considered useful for hedging against volatility in other asset types and spreading the risk. But things changed with the exceptional reactions to the early 2020 central bank crisis. As a result of loosening global financial conditions and increased investor risk appetite, as shown on this website, the values of cryptocurrencies and U.S. equities both rose sharply. Returns on Bitcoin, for instance, did not follow the S&P 500 (the US benchmark stock index), in any direction between 2017 and 2019. The daily correlation coefficient was just 0.01, but by 2020-21, the assets were growing and decreasing in lockstep at a rate of 0.36.
The cryptocurrency and decentralized finance business is expanding, but it is still not large enough to trigger a recession on its own. Moreover, many of crypto’s original developers and investors believe it will eventually replace fiat currencies.
Economists, though, can’t ignore the striking similarities between bitcoin and the subprime mortgages that helped trigger the Great Recession.
People with low credit scores took out hazardous mortgages in the early 2000s while house prices were rising, thinking they could rapidly refinance into better terms as property values soared. Approximately $1.3 trillion in 2007 was in mortgages that were classified as “subprime,” or riskier, financing options.
The article suggests that the relationship may be temporary. Since bitcoin and other cryptocurrencies have been suffering the downward impact of volatility due to the U.S. Federal Reserve’s ongoing rate hikes, this is encouraging news for optimistic crypto investors.
The cryptocurrency market seems to be leveling down, but more volatility might occur at any time. Cryptocurrency markets will continue to behave as they have been, but eventually, they will shift fast in a different direction, away from the stock market if past performance is any indication.
Banks and Regulators
The capacity of central banks to keep tabs on the financial system is threatened. As the world continues to combat terrorism and organized crime, this is a major issue. Central banks are worried that they may lose control of the money supply in the worst-case scenario.
Recently, officials didn’t give cryptocurrencies much thought since they had no practical use as money other than for people seeking anonymity. As Monday’s price drop demonstrated, they are hardly a reliable “store of value.” They are not frequently used because they are not commonly accepted. Furthermore, despite assurances to the contrary, digital currencies have been successfully hacked many times this year, with significant losses each time.
One reason authorities in developed economies have been sluggish to respond is the belief that cryptocurrencies are not their issue as long as problems linked to them mostly impact the rest of the globe. They seem to have bought into the concept that cryptocurrencies are fundamental assets to invest in and that the value of any one transaction is irrelevant, and instead are more concerned with protecting local investors and maintaining financial stability.
Major crypto market participants agree that regulation is inevitable and would want to contribute to its evolution. CEO of Binance, the biggest Bitcoin and cryptocurrency exchange in the world, Changpeng Zhao, has lately stated the need for regulators and industry stakeholders to collaborate on developing effective, worldwide, fit-for-purpose legislation.