Macro Insights Weekly: Crypto meltdown and systemic implications
- The year has seen failures of crypto lenders, crypto asset managers, and digital tokens
- These failures reveal little about tech shortcomings of the blockchain or design of cryptos
- But the sector is rife with interconnected lending and ownership
- There is also concentration risk and non-transparency in disclosures
- More regulation is on the way, as the public interest is at stake
Commentary: Crypto meltdown and systemic implications
Global markets breathed a loud sigh of relief on Thursday as US October CPI was somewhat favourable. Equities spiked, rates sold off, and the USD slumped. Even the beleaguered asset class of cryptocurrencies stabilised, having sold off heavily earlier in the week.
Unfortunately, the problems around the crypto ecosystem are too many and too deep to be offset meaningfully by a market-friendly monthly CPI print. While the crisis at FTX is the latest example, the year is been characterised by one failure after another, with crypto lenders Celsius and Voyager, hedge fund Three Arrows Capital, and digital tokens terraUSD and luna making up some of the most striking headlines.
These failures reveal little about technological shortcomings of the blockchain or design of the currencies themselves. Rather, they are symptomatic of gaps in regulatory oversight. Retail and institutional investors have poured hundreds of billions of dollars in this asset class, only to experience extraordinary volatility and deep losses due to major shortcoming in governance in the crypto ecosystem.
Just as it has been in most financial crises episodes in the past, the sector is rife with deep interconnection of ownership and lending, which create contagion when one entity faces losses due to a variety of reasons. Market correction, fraud, runaway speculation, unhedged exposure to macro shocks, all have been tripwires setting off investors’ alarm.
Additionally, the sector has surprisingly few market leaders, leading to concentration risk. Difficulties in one exchange creates system wide risks given their disproportionate scale. It also leads to opportunism among players, as seen in the case of FTX in the past week.
A common, and unsurprising, shortcoming in this year’s crypto-related failures has been the lack of transparency in financial reporting. Unlike regulated banks and non-bank financial corporations, the disclosure standards in the sector have lacked depth and uniformity, with bouts of worrisome revelations about asset position, exposure, accumulated losses, and liquidity eroding investor confidence.
The sector also typifies hype, exuberance, and fervent personalities that inevitably come with frontier technologies and developments. Expectations of quick gains and visions of a fundamentally transformed financial landscape have lured many to the sector, some of whom have seen losses mount.
Crypto-related losses, amounting to over USD2trln in market value in less than a year, is a correction of historic proportions. While the figures are large by any measure, risks to the global financial system appear limited. Many crypto firms are facing pressure from each-other, but the risks emerging from their difficulties do not appear to be spilling over to the traditional financial sector. So far so good, but a major wake up call, nonetheless.
The future of this industry will almost certainly be marked by tighter regulation. Lack of global systemic risk does not take away from the fact that many investors have not received sufficiently deep and accurate disclosures. Buyers should always beware, but when there are so many of them, the losses become of public interest. Surely, we’re there now.
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