Opinion: Cryptocurrency collapse may not just be about cryptocurrencies

The cryptocurrency market is under pressure. Unfortunately, even fund managers who have made a point of avoiding this unruly asset class in normal markets such as bonds and stocks need to pay attention.

A slight dip below the $68,000 peak in bitcoin’s price has become an avalanche, in part because of problems with so-called “stablecoins” – which are actually anything but stable but keep the market in sync. At the moment, the price of bitcoin shows a drop to around $27,000.

Yes, “crypto bros”, before you fill my inbox (again) with messages written in all caps: I am aware that some people continue to show positive returns on their investments. It is entirely plausible that the market will prove capable of recovering from this crisis, as it did after several other challenging episodes.

Say what you will about cryptocurrencies, the fan base they have is dedicated, and their persistence is impressive. However, anyone who entered the market from late 2020 onwards is in the red, and the drivers of this decline appear to be structural. Even some of the most loyal devotees of cryptocurrencies accept that this time the situation is different.

And who cares? Well, it’s sad for the people, many of whom are young and not very wealthy, who ignored all the warnings and put all the money they had saved in jingling cryptocurrencies, lured by claims that these lines of binary code had the ability to become serious rivals to the dollar, and underpin a new financial utopia. It is distasteful for cryptocurrency advocates who have tried to convince institutional investors that bitcoin could serve as a hedge against inflation, which is clearly a lie. Nayib Bukele, the president of El Salvador and a fanatical supporter of cryptocurrencies, may need to put aside his grandiose plans to create the Bitcoin City, and reduce it to a Bitcoin Village.

The open question is whether this all matters to traditional markets, which are already oscillating for their own reasons. Will what happened affect stocks and bonds?

Typically, what happens in cryptocurrencies stays in cryptocurrencies. But big moves can influence other markets. A repressive campaign by Chinese authorities nearly a year ago led to a temporary 30% drop in the price of bitcoin, and made observers of the German bond market surprised by the rise that its market registered as a result of the flight of securities. Cryptocurrency investors well seek security.

A finance executive tells me that his hedge fund clients are watching the situation closely now, and that many of them are serious about the possibility that a major crash in the cryptocurrency market, if it ever happens, could be to their advantage. most crucial of the markets, that of US Treasuries, once again under the idea that this would cause a race to find safer places to park money.

So the question is whether we are on track for a rerun of the 30% drop that bitcoin suffered last year. Signs that Tether is under pressure add to the feeling that the current price drop could be The Great Collapse. ‘Stablecoin’, which operates almost like a central bank for the cryptocurrency market, ran into trouble in its link to the dollar after a much less important ‘stablecoin’ TerraUSD collapsed earlier this week. The two digital currencies work differently, but the nuances can largely be described as the narcissism of small differences. Either these currencies can maintain their parity with the dollar or they cannot. If they can’t, the belief system that underpins cryptocurrencies is in big trouble.

Tether may also import to wider markets through a different channel. Its link to the dollar is maintained not through algorithmic sorcery, like TerraUSD, but through good old dollar reserves, or so Tether claims. Details on what exactly forms part of these reserves are scarce, and they are not subject to widely accepted accounting standards. But, in theory, the value of the reserves reaches US$ 80 billion, to back the volume of Tether that is in circulation.

Last year, credit rating agency Fitch warned that if Tether holders decide to convert their positions into real money, it could destabilize short-term credit markets in which the company claims to hold large amounts of funds.

“The rapid growth of stablecoin issuance could, over time, have implications for the functioning of short-term credit markets,” the Fitch analysts said, pointing to “the potential risks of asset contagion linked to the liquidation of reserve positions of ‘stablecoins'”.

Credit markets are already fluctuating due to upward pressure on benchmark interest rates. The idea that Tether could, in an emergency, dump some of its alleged reserves of $24 billion into “commercial papers,” $35 billion into US Treasuries and $4 billion into “corporate bonds, and precious metals”, in market conditions like the current ones, would certainly not help.

Now would be a good time for Tether to state, in more detail and with up-to-date numbers, what it has in its box. This would help investors understand where the vulnerabilities are and allay concerns about the backing of the virtual currency.

Paolo Ardoino, Tether’s vice president of technology, said in a Twitter conversation on Thursday that the group was prepared “to keep the dollar as a currency anchor at any cost”. He said the company had recently been acquiring “a ton” of US Treasuries and was prepared to sell them in order to defend the price of the digital currency.

Bond market investors, who are already hurt by the turmoil their market has been facing so far this year, would do well to monitor this situation closely.

Translation by Paulo Migliacci