Crypto alarmism has some basis

ORLANDO, FLORIDA: Regulators comparing the crypto craze to the US subprime mortgage bust of the 2000s may seem overly alarmist, but the more crypto integrates with traditional investing and markets, the more prescient these warnings may become.

The size of crypto markets relative to the financial asset universe remains tiny but they are growing rapidly, far quicker than curbs and controls are being imposed on the loosely regulated and rapidly evolving industry.

Barely a week goes by without a major bank or asset manager rolling out yet another crypto product or service. In recent days, Fidelity and BlackRock launched blockchain, crypto and metaverse exchange-traded funds, and Goldman Sachs offered its first Bitcoin-backed loan facility.

Policymakers clamouring to crack down on the “Wild West” of crypto — to counter risks from volatility to fraud, cybercrime to contagion — is nothing new.

What’s intriguing is the recent clutch of references to the US subprime housing market, whose unchecked expansion and collapse was a catalyst for the 2007-09 financial crisis.

Treasury Secretary Janet Yellen recently warned against repeating the mistakes of the 2000s when shadow banks and new financial products combined to fuel dangerous levels of risk.

ECB board member Fabio Panetta notes that crypto today is larger than the $1.3-trillion subprime market, and shares “similar dynamics” with the market that ultimately brought the world financial system to its knees.

Could crypto really wreak similar damage? On the face of it, no. But the more traditional banking and finance gets involved, the murkier the ties between the two grow, the more ordinary investors are exposed, and the more systemic the risks become.

Alastair Sewell of Fitch Ratings says the concern for regulators is the “on ramp” and “off ramp”, the points where the ordinary investor gets access to and exits a crypto investment.

“That will probably involve a bank, the link between traditional and digital finance. And some of the digital houses may tap capital markets, so investors are increasingly getting exposure to the broader crypto ecosystem around them,” Sewell said.

The positive correlation between Bitcoin and Wall Street has never been stronger. This suggests cryptocurrency is not the alternative to diversify portfolios or hedge against inflation, but is just as vulnerable as stocks in uncertain times.