David Jane
Premier Miton Macro Thematic Multi Asset Team
Crypto in all its various forms has been crashing lately and it might have more important consequences than simply reducing the apparent wealth of a few millennials.
It is easy to think of the whole Bitcoin/crypto sphere as an amusing sideshow to financial markets. However, the impact of its ongoing collapse may be more widespread than it first seems.
The most obvious effect is a wealth effect on other markets and consumer spending. It is known that a lot of the stimulus sent out by governments during the lockdowns found its way into crypto. In many cases, this money was leveraged into other assets. The paper gains would have led to additional consumption. This is now reversing. There is certainly potential for a negative wealth effect and its scale could be material.
The consequences of the crypto crash might be much more widespread than the simple wealth effect. Most crypto now is held on crypto exchanges. These exchanges offer leverage, like stockbroker accounts. A customer deposits money but is able, for a fee, to borrow to buy materially more assets. At the same time, customers are able to deposit their crypto assets for an interest payment. This is a form of time deposit or perhaps a stock lending scheme. Interest rates on these deposits can be very high.
These exchanges are, to all intents and purposes, banks. They take deposits, offer lending and so on. The big problem here is that they are very opaque and more entangled with the mainstream financial system than seems apparent.
The balance sheets of these so-called crypto exchanges, to the extent they are disclosed, tend to comprise loans to customers, other exchanges and other companies in the crypto sphere. These loans are secured in many cases by crypto assets. The give away that all is not as it seems is that the interest that these ‘banks’ offer in exchange for deposits is in many cases very high. This implies that the borrowers must be paying high rates, or the bank exchange itself is lacking dollar liquidity.
A number of these exchanges have already failed, with customers left with a material haircut on their assets. It seems that each failure weakens the rest, as the assets of each are the liabilities of the others. While this is disturbing in itself, there is a risk it leads to contagion into the wider financial markets and economy.
One recent knock-on effect is the revelation that part of Elon Musk’s funding for his withdrawn Twitter bid was coming from Binance, a crypto exchange. Whether possible weakness at this exchange led to the withdrawal of their offer of funding, and hence Musk’s failure to complete the deal is unknown, but its withdrawal is a disturbing piece of evidence that the crypto collapse is becoming more systemic.
Another sign of potential contagion is the collapse of a series of hedge funds, Three Arrows Capital, which was involved in crypto and other similar assets and at one time was meant to have $10bn under management1. It is now in liquidation, but its liabilities are others’ assets. It seems these assets are now potentially worthless, as are the investors’ subscriptions. This appears to be having knock on effects at another financial institution, Genesis Global Trading, which is also involved in mainstream financial markets.
Total losses in crypto since the 2021 peak are estimated at over $2tn2, which is certainly a material sum and around 8% of US GDP ($23tn as at December 2021)3. Arguably, we are only at the beginning of the unravelling process and the knock-on effects onto mainstream financial markets might only just be beginning to be felt. We remain very cautious at present and are running defensive portfolios, at least until we are able to scale the impacts of this and other consequences of monetary tightening on the economy and financial markets.
