The following article originally appeared in CoinDesk Weekly, a custom-curated newsletter delivered every Sunday exclusively to our subscribers.
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A common thought experiment within the crypto community is to ponder how cryptocurrencies would fare within the event of another global financial meltdown.
It is not an idle question. there's a number of troubling developments within the global economy: the threat of a trade war, jitters in Italian debt markets, problems at Deutsche Bank and new emerging market crises in Turkey and Argentina.
Meanwhile, central banks, led by the U.S. Federal Reserve System , are tightening or signaling tighter monetary policy. That’s putting a brake on the large gains that low interest rates and quantitative easing had bestowed on global markets within the eight years since the top of the last crisis.
With this mix of risk factors already live , there’s always an opportunity that some unforeseen trigger could depart another terrified rush for the exits among global investors.
What would the impact get on bitcoin and other cryptocurrencies? Would their reputation as independent assets see them enjoy safe-haven inflows? Or would the market-wide reduction in risk appetite spread wide enough that crypto assets get trapped within the selloff?
Some crypto hodlers salivate at the thought of market panic.
They contend that, unlike the 2008-2009 collapse, when Satoshi Nakamoto’s newly launched cryptocurrency was essentially out of sight and unavailable to the hordes seeking a haven from the fiat world’s chaos, bitcoin is now widely known as a more versatile alternative to traditional flight-to-safety assets like gold.
In a crisis, they say, bitcoin could shine – as might other cryptocurrencies designed as alternatives to fiat cash like monero and zcash. Unaffected by future monetary policy responses, immune from draconian interventions like the Cypriot deposit freeze of 2013, and simply acquired, they might prove their value as digital havens for the digital age in such a flash . Accordingly, the bulls’ argument goes, their prices would surge.
On the opposite hand, if there’s enough of a market-wide departure from risky investments, it’s hard to not see this sector being swept up in it.
Just as the foremost extreme gains in crypto prices within the latter a part of 2017 were inextricably linked to the rapid “risk on” uptrend seen in stocks, commodities and emerging-market assets, so too a serious selloff could easily infect these new markets.
Cryptocurrencies and tokens are perceived by most ordinary investors as high-risk assets – you purchase them with money you'll afford to lose when you’re feeling upbeat about market prospects. When the mood sours, this class of investment is usually the primary to be retrenched as investors scramble to urge cash.
At $300 billion, consistent with Coinmarketcap’s undoubtedly inflated estimates, the market cap of the general crypto token market is quite 3 times its value of a year ago (even though it’s down quite half from its peak in early January).
But it’s but 1 percent of the end-2017 market cap of $54.8 trillion for the S&P Global Broad Market Index, which incorporates most stocks from 48 countries. If risk-hungry investors are panicking and searching for things to dump – or for that matter if they’re trying to find something safe to shop for – it won’t take much of their funds to maneuver the crypto markets, a method or another.
Backing the bitcoin bulls’ argument is that the incontrovertible fact that correlations between cryptocurrency and mainstream risk assets – the degree to which prices move in tandem with one another – are quite low.
A 90-day matrix compiled by analytics firm Sifr put bitcoin’s correlation with the S&P 500 index of U.S. equities at minus-0.14. That’s a statistically neutral position since 1 represents an ideal direct correlation while -1 may be a perfectly negative relationship.
But they assert that during a crisis “all correlations attend 1.” The panicked state of the gang , with investors selling whatever they will offload to hide debts and margin calls, means everything could leave with the flood.
Intellectually, too, that kind of wholesale downturn would comfortably stand as a logical counterpoint to the conditions seen last year when market valuations reached excessive levels. We cannot separate the flood of cash that flew into crypto at the top of the year from the very fact that eight years of quantitative easing had driven a “hunt for yield” in once-obscure markets because the return shrank on now pricey mainstream investments like corporate bonds.
With bond funds paying little quite , say, 2 percent for years, bitcoin looked attractive to mainstream investors. When that artificially-stoked liquidity disappears, the reverse could happen.
Despite all of this, I do believe a worldwide financial crisis might be a crucial testing moment for crypto assets.
Perhaps there’ll be a two-phase effect. within the immediate aftermath of the panic, there would be a selloff as every market is hit by the liquidity squeeze.
But after things settle, one can imagine that the narrative around bitcoin’s uncorrelated returns and its status as a hedge against government and banking risk would gain more attention.
Just like the mid-2013 surge in bitcoin that accompanied the Cypriot crisis’ lesson that “they can come for your checking account but not for your private keys,” so too a wider financial crunch could spur conversation around bitcoin’s immutable, decentralized qualities and help build the case for purchasing it.
The wider point here is that, whether it’s as an aligned element that rises and falls in sync with the broader marketplace or as a contrasting alternative thereto , cryptocurrencies can’t be viewed in isolation from the remainder of the planet .