A weekend blog in the COINSWITCH webpage sincerely attempts to convince investors to remain calm and composed in a turbulent crypto market citing massive sell-offs as the reason for its downfall. Following the so-called stable coin TerraUSD (UST) collapse, it had a knock-on effect across the crypto market. Bitcoin (BTC), the most traded crypto (after Tether), is struggling to have a resistance level of $28,000. Descending from its historical peak of $67,566 (November 8, 2021), it has lost almost 60% of its value in six months. Once perceived as an asset to diversify risk in the new age investors’ portfolio, the crypto assets are in trouble today.The crash has been contagious across other digital assets, including Stable coins and NFTs (Non-Fungible Tokens). Deus Finance’s stablecoin DEI has also witnessed sharp fall in its price. CoinGecko reports a decline in DEI’s price by 42% in the last seven days.
This is not new. In 2021, the Iron Finance Protocol (which includes $IRON and $TITAN tokens) collapsed, losing nearly $2 billion in value in a day. What’s wrong with this asset class? Have cryptos become stocks of late?
The crypto assets have received attention among researchers and analysts alike. A Google search for “crypto crash” throws 19,700 lakh results in 0.51 seconds. A research paper published by Gil-Alana et al., (2020) in an International Journal, Research in International Business and Finance, finds no relationship between crypto currencies and stock market indices over a long period. To quote the authors, “crypto currencies are decoupled from the mainstream financial and economic assets. The findings indicate the significant role of crypto-currencies in investor portfolios since they serve as a diversification option for investors. It also confirms that cryptocurrency is a new investment asset class”.
On the contrary, a recent blog by Adrian et al., (2022) published by the IMF points towards a stronger correlation between cryptocurrencies/assets and stock markets. Post pandemic, the central banks worldwide pursued ultra-accommodative monetary policies, and such easy financial conditions witnessed an increased risk appetite among investors. The investors flooded the stock markets and crypto markets. For instance, Adrian et al., (2022) finds the correlation of the Bitcoin-US stock to have become stronger during the pandemic. These two assets moved together during 2020-21, rose together and fell together.
In India, in the first half of the financial year 2021-22, investment in stocks and mutual funds increased, and the participation of retail investors in the stock market also soared. Data from SEBI shows that the market’s retail and private investors reached 8.97 crore in March 2022 from 5.51 crore in March 2021, a 63% rise in the number of investors in one year. If we consider some of the most powerful and influential countries in the world, we can see that there has been a significant increase in stock market capitalization recently. Among drivers, the negative real interest rate of bank deposits and govt., small savings schemes were significant. The RBI kept on reducing the policy repo rate after August 2018 by adopting the easy monetary policy as its response to structural slowdown and the COVID-19 pandemic. Given the system’s excess liquidity, low bank, and post office interest rates, a chunk of ordinary retail investors moved towards stock markets, secondary and primary. The IPO rush also saw oversubscriptions.
But the recent fall in stock indices and crypto prices signal that crypto is no longer diversifying risk as was perceived by investors earlier. Crypto is perceived as a near-stock and moves together with stocks now.
The factors that affect investor sentiments in stock markets have begun to affect the crypto investor sentiments. The strong correlation between NIFTY 50 and Bitcoin proves that crypto-currencies are no longer treated as a hedge against unforeseen situations. The strong positive correlation between NIFTY 50 and Bitcoin at 0.91 for last five years supports the argument. Even considering the stock market crash in India on March 23, 2020 due to panic brought forward by the Covid-19 pandemic and the stringent lockdown measures, the movement of the stock market and Bitcoin price is robust at a positive 0.87 correlation.
Additionally, the positive correlation between Bitcoin and the Gold prices (Correlation for last 5-yr price movement is 0.68) has faded away recently and has been hovering in negative territory for the last 2 years. From March 2020 to date, the correlation between Bitcoin and the Gold prices has been negative (-0.16). Hence the position of cryptocurrency in the individual investors’ basket is changed from hedging to a highly rewarding asset class.
What is even more dangerous is that the crypto asset class is built on expectations only without any fundamentals like stocks. The so-called Stablecoins and NFTs have also not survived the test in the market. The fundamental belief of an investor regarding these stable coins is jeopardised. Stablecoins, which were meant to be a hedge against cryptocurrency volatility and were easier to move between decentralized exchanges, is no more backed by reserves to ensure they maintain that one-to-one peg in all cases. Stable coins like TerraUSD (UST) are decentralized based on algorithms and smart contracts that incentivize traders to maintain a steady price. Their prices are based on the confidence and trust in the economic incentives of the Stablecoin issuer’s underlying ecosystem, and once that trust and investor demand evaporates, they quickly fail. The primary risk of Stablecoins is that they are not fully backed by the reserve currencies they say they are.
The global macroeconomic uncertainty, rising interest rates, and the return of inflation have affected investor sentiments. The Russia-Ukraine conflict has added fuel to this fire. In such an environment, investors ought to be extremely cautious in their investment decisions in general and crypto assets in particular. Historically speaking, we have always seen crashes as well as corrections in stock markets. Is that possible in crypto markets? The answer probably is no. It’s time for the regulator(s) to wake up and stop this bloodbath in the cryptomarket. The urgency of regulatory response in the wake of this crash is vital. In India, the absence of financial literacy initiatives by the regulator or the govt., in the cryptocurrency segment has been encouraging the crypto exchanges to lure the medium to low segment investor class by offering to enter the market with a meagre contribution, even lower than mutual fund SIP or stock market investment. Though the last Budget announced taxing digital virtual assets exorbitantly, the confusion remains on its legality, and investors still see this asset as the golden deer.
(By Debashis Acharya And Bibekananda Panda)
[DISCLAIMER: This is an opinion piece. The views expressed are the authors’ own and have nothing to do with OTV’s charter or views. OTV does not assume any responsibility or liability for the same. Debashis Acharya teaches in the School of Economics, University of Hyderabad, and Panda is an Economist at the State Bank of India.]