On Tuesday, Bitcoin price fell below $30,000 for the first time in 10 months while all cryptocurrency have lost about $800 billion in market value in the past month. This is according to data from CoinMarketCap. Cryptocurrency investors are now worried about the tightening monetary policy.
Compared to the Fed’s tightening cycle which started in 2016, the cryptocurrency market has grown bigger. This has raised concerns about its interconnectivity with the other financial system.
What is the Size of the Cryptocurrency Market?
In November 2021, the largest cryptocurrency by market capitalization, Bitcoin, hit an all-time high of above $68,000, which in turn pushed the crypto market value to $3 trillion, according to CoinGecko. On Tuesday, this figure stood at $1.51 trillion.
Bitcoin alone accounts for about $600 billion of that value, followed by Ethereum with a market cap of $285 billion.
It is true that cryptocurrencies have enjoyed massive growth since their inception, but their market is still relatively small.
The U.S equity markets, for instance, are estimated to be worth $49 trillion while the Securities Industry and Financial Markets Association were estimated to be worth $52.9 trillion by the end of 2021.
Who are the Cryptocurrency Owners and Traders?
Although cryptocurrency started as a retail phenomenon, institutions such as banks, exchanges, companies, mutual funds, and hedge funds are growing interest in this industry at a fast rate. It is however hard to get data on the proportion of institutional versus retail investors in the cryptocurrency market, but Coinbase, the largest cryptocurrency exchange platform in the world, has stated that institutional and retail investors each accounted for about 50% of assets on its platform in the fourth quarter.
In 2021, cryptocurrency institutional investors traded $1.14 trillion, up from $120 billion in 2020, according to Coinbase.
Most of the Bitcoin and Ethereum in circulation today are only held by a few people and institutions. A National Bureau of Economic Research (NBER) report released in October showed that one-third of the Bitcoin market is controlled by 10,000 individual and institutional Bitcoin investors.
A University of Chicago research established that approximately 14% of Americans had invested in digital assets by 2021.
Can the Crypto Crash Cripple the Financial System?
Although the entire crypto market is relatively small, the U.S. Federal Reserve, Treasury Department, and the international Financial Stability Board have marked stablecoins, which are digital tokens that are pegged to the value of traditional assets, as a potential threat to financial stability.
In most cases, stablecoins are used to facilitate trading in other digital assets. They function under the backing of assets that become illiquid or lose value during times of market stress, while the disclosures and rules that surround those assets and investors’ redemption rights are questionable.
According to regulators, this can make investors lose their confidence in stablecoins, particularly during times of market stress.
This was witnessed on Monday when TerraUSD, a well-known stablecoin, broke its 1:1 peg to the dollar and dropped to as low as $0.67 according to data from CoinGecko. The move partly contributed to the fall in Bitcoin price.
Although TerraUSD maintains its connection to the dollar using an algorithm, an investor runs on stablecoins that keep reserves in the form of assets like cash or commercial paper, which can spill over to the traditional financial system. This can cause stress on the underlying asset classes.
With the fortunes of most companies connected to the performance of crypto assets and the traditional financial institutions getting involved in the asset class, there is the emergence of other risks. In March, the acting Comptroller of the crypto warned that the cryptocurrency derivatives and unhedged crypto exposures could trip up banks, not forgetting that they have very little historical price data.
The regulators are still divided on the amount of threat the crypto crash poses to the financial system and the entire economy.