The drivers of the implosion in risk asset values ​​that began in the crypto market last November are obvious. It is the burst of inflation to its highest level in 40 years and the inevitable, albeit belated, response from the Federal Reserve in the form of higher interest rates and reduced liquidity.

The implications of the change in monetary policy for conventional assets are obvious. When the risk-free rate – the rate on 10-year bonds used to discount companies’ future cash flows – rises, the net present values ​​of those cash flows fall.

<a class=Stock markets are also crashing as investors face a number of headwinds, but the crypto downturn started earlier.” loading=”lazy” src=”https://static.ffx.io/images/$zoom_0.14%2C$multiply_0.4431%2C$ratio_1.5%2C$width_756%2C$x_0%2C$y_0/t_crop_custom/q_86%2Cf_auto/92c4e2df7c5441d38a0f82caac6bc4a491642434″ height=”224″ width=”335″ srcset=”https://static.ffx.io/images/$zoom_0.14%2C$multiply_0.4431%2C$ratio_1.5%2C$width_756%2C$x_0%2C$y_0/t_crop_custom/q_86%2Cf_auto/92c4e2df7c5441d38a0f82caac6bc4a491642434, https://static.ffx.io/images/$zoom_0.14%2C$multiply_0.8862%2C$ratio_1.5%2C$width_756%2C$x_0%2C$y_0/t_crop_custom/q_62%2Cf_auto/92c4e2df7c5441d38a0f82caac6bc4a491642434 2x”/>

Stock markets are also crashing as investors face a number of headwinds, but the crypto downturn started earlier.Credit:Bloomberg

Crypto assets typically have no cash flow, so the value destruction that is occurring is likely related to the impact of external parameters on investor psychology and the growing risk aversion that has taken place. developed since the end of last year.

Diminished liquidity in financial systems generally could also play a role, as leveraged investors seek to cash in or cash out to meet their liabilities elsewhere.

The fact that the crypto market downturn started a little earlier than the broader sell-off in riskier stocks is interesting. The “mainstreaming” of crypto last year attracted institutional funds and wider use of sophisticated trading strategies, including the use of leverage and derivatives.

Loading

The exodus of these relatively new investors and the unwinding of their positions could be another element in explaining the violent movements in the value of crypto assets.

The crypto collapse is already claiming victims.

Algorithmic stablecoin TerraUSD – which supposedly uses financial engineering to perfectly peg its value to the US dollar, fell below 70 US cents this week after experiencing something akin to a “run”.

Coincidentally, on Monday, the Federal Reserve warned in its latest Financial Stability Report that stablecoins were vulnerable to runs because they were backed by assets that could lose value or become illiquid during times of stress.

He noted that stablecoins are increasingly being used to meet margin requirements for leveraged trades in other cryptocurrencies, which could amplify volatility and increase redemption risks.

The dominant stablecoin, Tether, has so far held at or slightly below US$1.

It is not just crypto assets that are destroyed.

The largest US cryptocurrency exchange, Coinbase, listed on the Nasdaq stock exchange last year. Its stock price peaked at US$357 last November. It is now around US$73.

This week it announced a loss of $430 million after a 35% drop in revenue. He cited plummeting crypto asset prices and increased volatility for a 44% drop in trading volumes – a drop that provides insight into the extent to which crypto investors are fleeing the market.

Their extraordinary volatility also renders them virtually useless for the purposes originally envisioned for cryptocurrencies, mediums of exchange, and an alternative to fiat currencies.

This exodus creates a form of network effects. When the crypto market was booming last year, it attracted investors. This increased demand has pushed up prices and increased liquidity in asset markets.

The November implosion left investors facing massive losses and triggered a reversal of these network effects. This explains why the declines in value have been so precipitous.

True believers in crypto will say they have seen this before. Just three years ago, Bitcoin, for example, was only trading at around $5,000. What plummets could eventually skyrocket, given the leverage of crypto assets on macro settings.

Loading

The fall in their valuators has dispelled any notion that they are uncorrelated to other risky assets and therefore offer diversification. This is not the case — they provide a more concentrated and leveraged exposure to the risk environment, which is great in a “risky” environment, but disastrous when investors’ risk appetite decreases considerably.

Whatever happens in the future – there are a lot of interesting and potentially big ideas being developed in the crypto space – at this point, these are assets for speculation rather than investing.

Their extraordinary volatility also renders them virtually useless for the purposes originally envisioned for cryptocurrencies, mediums of exchange, and an alternative to fiat currencies.

About The Author

Related Posts