Lessons from the latest crypto market unwind
Market stress has not been limited to equities, with crypto risk positions rapidly unwinding, too. Bitcoin has fallen below half its peak value and shares in exchange Coinbase have nearly halved this week amid a collapse in trading volumes. Algorithmic sta-blecoin TerraUSD has seen its dollar peg fall apart, and pressure on #1 stablecoin tether has seen it slip as much as USD 0.05 below parity today.
We have long warned our clients over the speculative nature of most digital assets, advising they instead focus on an asset allocation strategy that diversifies their portfolios and matches their return and risk goals. We maintain this view and make several observations on the back of recent events:
• We believe crypto has been ineffective as a portfolio diversifier or inflation hedge. The claim that crypto is uncorrelated with traditional financial assets has weakened substantially – with Bitcoin and Ether both showing strong positive correlation (>0.95) with the Nasdaq and the ARK ETF. And yet crypto offers less liquidity, more volatility, and high inter-coin correlation. Bitcoin and other crypto have also failed to act as a “digital gold” or inflation hedge – with asset prices rapidly deflating into a high inflation and higher rates regime, demonstrating their reliance on expansive monetary policy conditions.
• Regulators need to step up still, and heavy retail losses may speed this up, in our view. Developed market regulators have been slow to roll out more concrete rules, whether due to legislative gridlock, uncertainty on regulatory purview, or fear of disrupting innovation. We think significant, widespread losses for retail crypto participants will add to regulatory urgency and increase the incentive for more meaningful action. This week, US Treasury secretary Janet Yellen said stablecoin legislation would come within the year, while SEC chair Gary Gensler has accused some exchanges of unethical trading practices that require oversight.
• Increased trust is still needed for crypto to go more mainstream. Opaque market leverage, unscrupulous exchange behaviour, and not-so- stable stablecoins can erode user trust and further adoption of crypto networks. By contrast, effective regulation may actually be a growth lever and foster more innovation. We think clearer laws and capital rules, meaningful non-banking entity oversight, and platform standardization can together increase financial institution participation, and help deliver on the promise of the blockchain and digital ledger technology (DLT).
As the monetary regime that fueled the crypto rally unwinds, we think investors should avoid trying to call a bottom on these highly speculative assets. At present, we see more attractive options for portfolio hedges, such as via healthcare and commodity exposure, and also other ways to take on portfolio risk, such as by tilting equity allocations toward value and the energy sector.
Investors with a long-term view can consider exposure to digital ledger technology opportunities via select platform and enabler companies, or via private market investments in early-stage companies. Strong VC investments in blockchain and fintech, which according to Cointelegraph Research hit USD 33bn in FY2021 and 14.6bn in 1Q22 alone, should help ensure quality innovators have the capital to weather a potential “crypto winter.” Stepping back, we think blockchainbased digital money has begun to show its utility, and we expect more non-banking entities, commercial lenders, and financial institutions to harness these new tools to improve their efficiency and service offering.