Are we seeing the first systemic crisis in the crypto asset 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 this week fell to its lowest level since 2020, looks like a giant stress test for market participants. For those who don’t make it, just a reminder: in this unregulated market, there is no customer protection in case of bankruptcy, nor any crypto bank.too big too bad“.

A disturbing sequence of bad news

The news of recent weeks is causing concern in the sector and raising fears of contagion. After the algorithmic stablecoin Terra (indirectly pegged to the dollar) went bankrupt at the speed of light, going from a capitalization of $40 billion to zero, decentralized financial platform Celsius, one of the largest lenders in the cryptocurrency market (1.7 million customers, $11 billion assets under management), announced on Sunday that it is suspending sinus dies transactions (transfers, withdrawals, exchanges) on their platform. She is short of cash. According to Financial Timesbetween March and May, a billion dollars would have left his system.

Systemic risk occurs when a domino effect threatens the entire system. Celsius, for example, borrowed $500 million from Tether, a dollar-backed stablecoin but also dollar-backed. In the world of decentralized finance, loans are “collateralized” in cryptocurrencies such as bitcoin. If the price of bitcoin falls, the borrower must deposit new bitcoins. The whole system is based on the participation of more and more actors in this economy, otherwise it gets stuck. From there, chain reactions can be expected.

Systemic risk

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

For now, these risks remain limited. However, according to a Fidelity Digital Assets survey, 56% of European institutional investors are involved in this asset class to some extent (compared to 45% in 2020). large international banks, however, have very little exposure to. However, it is not impossible for the ECB that the crypto-financial crisis will affect the rest of the economy due to the direct impact of these assets, welfare effects, the impact on the confidence of economic agents and the use of cryptocurrencies. as a means of payment.

In addition, the proliferation of derivative products (particularly leveraged) increases the risk of exposure to crypto assets. Speaking of derivatives, the report contains a “fun” statistic: the size of the crypto asset market today is equivalent to mortgage 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 cycle has been completed and we are risking the equivalent of a “bank run” with investors seeking to reclaim their stake at any cost, creating liquidity risk for platforms. Because, unlike what has been put in place in the regulated financial sector, given prudential requirements (financial institutions are required to deposit a certain amount of capital in front of their assets) and stress tests, companies in the crypto industry do not have these guarantees and can quickly dry up. funds. The vicious circle even extends to mining, with some miners shutting down because their activities are no longer profitable.

All this has very concrete consequences. The approximately 1,500 layoffs announced in recent days by decentralized finance platform BlockFi and trading platforms (which made a splash during the Super Bowl) and Coinbase are not virtual. Some companies may also suffer indirectly from the collapse. Tesla, for example, sets records in time $500 million a net loss – albeit unrealized – from their investment in cryptocurrencies. An entity may be required to recognize an impairment charge.

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