Are we witnessing the first systemic crisis in the cryptocurrency market?

A wave of panic swept through the cryptocurrency market. Are we seeing the first systemic crisis in the industry? Who will be his Lehman Brothers? The collapse of bitcoin, which fell to its lowest level since 2020 this week, looks like a giant stress test for market participants. For those who do not pass, we remind you: in this unregulated market there is no protection of customers in case of bankruptcy, no cryptocurrency.too big, too bad“.

An alarming series of bad news

Recent news has caused concern in the sector and concerns about infection. After the algorithmic stablecoin Terra (indirectly pegged to the dollar) went bankrupt at the speed of light, moving from a market capitalization of $ 40 billion to zero, the decentralized financial platform Celsius, one of the largest creditors in the cryptocurrency market (1.7 million customers, 11 dollars). billion assets under management), announced on Sunday the suspension the sinus dies transactions (transfers, withdrawals, exchanges) on your platform. She lacks cash. According to FinancialTimesfrom March to May, a billion dollars would leave her system.

Systemic risk exists when the whole system is threatened by a domino effect. Celsius, for example, borrowed $ 500 million from Tether, a dollar-backed but also dollar-backed stablecoin. In the world of decentralized finance, loans are “pledged” in cryptocurrencies, such as bitcoins. If the price of bitcoin falls, the borrower must make new bitcoins. The whole system is based on the participation of more and more actors in this economy, otherwise it will seize. From here you can expect chain reactions.

Systemic risk

In May 2022, the European Central Bank (ECB) published a report on the risks of cryptocurrencies for the stability of the financial system. It is logical that the more these markets are interconnected with traditional financial markets, the more systemic risks increase. However, the report notes an increase in the involvement of traditional investors in cryptocurrencies. He concludes that if “The current growth trajectory continues in size and complexity, and if financial institutions become more involved, cryptocurrencies pose a risk to financial stability.”

So far, these risks remain limited. However, according to a Fidelity Digital Assets survey, 56% of European institutional investors have some degree of influence over this asset class (compared to 45% in 2020). The However, large international banks have very little protection. For the ECB, however, it is possible that the crypto-financial crisis will have consequences for the rest of the economy due to the direct impact on these assets, the impact on wealth, the impact on the trust of economic agents and the use of cryptocurrencies. as a means of payment.

In addition, the proliferation of derivatives (especially leverage) increases the risk of exposure to cryptocurrencies. Speaking of derivatives, the report contains “funny” statistics: the size of the cryptocurrency market today is the equivalent of substandard securitization before the 2008 crisis…

Chain reactions

At the moment, if there is a systemic crisis, it is limited to the world of cryptocurrencies. A vicious circle has begun, and we risk the equivalent of a “bank run” when investors seek to recoup their stake at any cost, creating liquidity risk for the platforms. Because, contrary to what has been introduced in the regulated financial sector, given prudential requirements (financial institutions are required to invest a certain amount of capital in front of their assets) and stress tests, crypto companies do not have these guarantees and can quickly run out of money. The vicious circle extends even to mining, where some miners close the curtain because their activities are no longer profitable.

All this has very concrete consequences. The approximately 1,500 layoffs announced in recent days by the decentralized financial platform BlockFi and the trading platforms (which caused a stir with its advertising during the Super Cup) and Coinbase are not virtual. Some companies may also be indirectly affected by the crash. Tesla, for example, writes on time $ 500 million net loss, albeit unrealized, from cryptocurrency investments. The company may be required to recognize impairment charges.

As for El Salvador, which made bitcoin a legal tender, its bitcoin reserves have shrunk by $ 50 million. Knowing that the country’s public debt was 85% of GDP in 2021 and that El Salvador’s debt matures by $ 800 million in January 2023, the risk of default will increase.