A disastrous week in the cryptocurrency markets has once again cast doubt on the long-term viability of a bold new financial sector. An ostensibly stable coin or currency has lost almost all of its value and the value of bitcoin has fallen to a 12-month low even as investors look for an inflation hedge.
But those in the sector point to the increased participation of traditional financial institutions as one of the reasons for the bitcoin price drop, and also a sign of the space becoming more mature compared to the past few years.
The collapse of TerraUSD, the stablecoin, began early last week. It was designed to be pegged to the dollar and broke from its $1 (80 pence) peg, falling to about 12 cents while the cryptocurrency, linked to it, dropped from about $80 in the first week of May to one-thousandth of a cent.
Stable coins are an important part of the cryptocurrency ecosystem and traders use them to maintain the value of their assets without converting their reserves into fiat currency like US dollars or British pounds.
Despite Terra’s internal meltdown and bitcoin now trading at $30,000, down more than halving since its all-time high in November, those in the sector see it as just another step in the cryptocurrency’s transformation into a mainstream investment category.
“It is important to remember that it is still an emerging asset class and considered a risky investment, so it is not surprising to see a sell-off in the massive liquidation of risk,” said Rehana Sharif Al Askari, managing director of investor relations at investment firm Grayscale.
For crypto veterans, the current bitcoin slump is a sign of a maturing asset. Last month, the 90-day correlation between bitcoin and the S&P 500 rose to 0.49, the highest since October 2020, indicating a fairly strong correlation with traditional stocks.
This is due to a shift in the dominant cryptocurrency traders, said an analyst at Morgan Stanley. “We believe that the increased participation of institutions sensitive to the availability of capital and therefore interest rates, has partially contributed to the significant correlation between bitcoin and equities,” Sheena Shah said last week.
Shah added that the way out of this link is for bitcoin to become a widespread payment method, which “is unlikely to happen soon.”
This close connection to the traditional market comes with some obvious drawbacks to cryptocurrency as an alternative investment space. For example, when the US Federal Reserve decided to raise the benchmark interest rate by half a percentage point to a range of 0.75 percent to 1 percent two weeks ago, bitcoin fell 14 percent in response. “Bitcoin is a global asset…and is therefore subject to the realities of monetary tightening, inflation liquidity provisions and central bank policies,” said James Cheek, senior communication analyst at Glassnode. Check added that the “always open” bitcoin market means the cryptocurrency has been a leading indicator of global sentiment, given the potential for trading when stock markets are closed.
Stable coins are needed for the crypto world to function. Most of the stablecoins are tied to fiat currency and backed by cash or an equivalent such as the market leading Tether (USDT).
Although algorithmic stablecoins such as Terra are a small part of the stablecoin asset class, their collapse has been mirrored across the market and impacted on the strongly backed stablecoins.
For example, which holds more than $34.5 billion in Treasuries and more than $4.2 billion in cash and bank deposits, it recently pegged at $0.9935, the largest deviation in more than two years as terrified investors jumped.
This combination of unstable stablecoins and vulnerabilities for retail investors has piqued the interest of regulators.
Last week, it was reported that the European Commission is considering strict limits on stablecoins, deeming them unsuitable to replace fiat currencies like the euro. This news comes as lawmakers in Europe are finalizing a landmark crypto law known as Markets in Crypto Assets Regulatory (MiCA) to develop a legal framework for crypto assets.
Across the Atlantic, US regulators have been debating how to regulate stablecoins, with members of the Senate Banking Committee introducing a bill in April to help the government determine how different agencies should deal with companies that issue stablecoins backed by dollars or other assets.
In the wake of TERRA’s collapse, Treasury Secretary Janet Yellen told lawmakers on the House Financial Services Committee:[stablecoins] presenting the same kind of risk ‘inherent in the management of banks.
There is a suggestion that this crypto sale is just another step on the road to greater integration with the broader financial system. “Total outflows as a percentage under management were 5 per cent of assets under management in 2018, this time at 1 per cent,” said James Butterville, head of research at CoinShares, director of digital assets. The massive expansion of the crypto space means that this type of outflow is much larger than the 2018 sell-off, but it does indicate that investors aren’t dumping the sell-off and working as much as they did in the past. Well, those who did not lose their shirts in the collapse of Terra.
Butterfly said the purchase was already happening again. “In the past two weeks, we have seen inflows as investors take advantage of the recent price weakness,” he said.
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