With the volatility of cryptocurrencies likely to persist — Bitcoin alone traded in a $30,000-to-$44,000 range last week — more people are wondering whether this will spell trouble for other financial assets such as stocks and bonds. The answer to this “crypto contagion” question, if considered narrowly, is no. It gets more complicated, however, in the broader market context, particularly in view of the cross-ownership of assets, leverage and market functioning.
Here are four contagion questions that investors need to consider:
Will crypto volatility continue?
Yes. The likely persistence of volatility is due to a tug-of-war that will become more tense and multidimensional.
One notable aspect of cryptos this year, and especially of Bitcoin, has been the competing pull between and within the private and public sectors. This phenomenon is likely to intensify in the months ahead, with each side also going through its own far-from-linear evolution.
Until the last 10 days or so, the private sector was fueling what appeared to be an accelerating self-reinforcing process of broader adoption of Bitcoin as a form of payment and a store of value. The most visible impetus came in February, when Elon Musk announced that Tesla had invested some of its cash in Bitcoin and would also accept it as payment for cars.
This encouraged other companies to follow suit, pushing Bitcoin prices higher and attracting more investors. With nontraditional providers of crypto trading platforms prospering as a result, such as Coinbase’s direct listing on Nasdaq, more traditional broker-dealers looked to participate by providing their own vehicles for interested investors.
This seemingly unstoppable momentum was shaken last week not just by doubt about the continued enthusiasm of Musk and Tesla but also public sector pushback that’s intensifying in magnitude and expanding in scale.
Many governments and central banks remain worried about the risks that cryptos pose for national security and economic and financial stability. Long-standing concerns have focused on the facilitation of illicit payments, weak investor protection, the possibility of eroding the effectiveness of monetary policy and the loss of the seigniorage that comes with the widespread issuance and use of competing currencies.
Several countries, including some large ones with significant international demonstration effects such as China and the U.K., are now investigating more seriously issuing central bank digital currencies, or what some think of as centralized cryptocurrencies. The more they advance on this, the greater the inclination they will have to make room for their own digital currencies by putting regulatory pressure on the attractiveness and viability of decentralized variants such as Bitcoin. Indeed, this could well be a motivation behind China’s recent anti-Bitcoin actions.
Is there a strong formal connection between crypto and more traditional asset classes?
On the whole, no. They tend to live in their own ecosystems, at least for now.
Based on their fundamental attributes, cryptos are neither physical nor financial substitutes for stocks, bonds and commodities. While their loudest backers highlight their role as a decentralized global currency that will quickly proliferate in the payments and savings ecosystems, the ability to do so requires the type of institutional maturation and relative price stability that will take years to establish. Moreover, cryptos will have to find a solution to the problem of high energy consumption.