The growing unease of governments with cryptos poses a significant risk, and any fallout will ripple through other markets
Comments in the past few weeks by leading voices in the regulatory world have raised the risk of tightening controls over cryptocurrencies, like the most popular Bitcoin. US Treasury Secretary, Janet Yellen, said that cryptos offered promise but they had also been used to launder money by drug traffickers and terrorists. She did, however, add that innovation could help address these problems and the technology could be used to plug digital gaps.
European Central Bank President, Christine Lagarde, expressed similar concern, calling for global regulation of Bitcoin. At a Reuters News Conference, she said: “(Bitcoin) is a highly speculative asset, which has conducted some funny business and some interesting and totally reprehensible money laundering activity”. If that’s not signal enough, one wonders what is—both the US and EU are talking regulation.
India is not far behind. Recently, minister of state for finance Anurag Singh Thakur said that a cryptocurrency bill was being finalised and it would be sent to Union Cabinet soon. Finance Minister, Nirmala Sitharaman, while responding to question in the Rajya Sabha too indicated that a high-level committee—formed to study issues related to virtual currencies—had recommended that all private cryptocurrencies be prohibited in the country. Whether the Government will go all the way and ban cryptos, one can’t say, but the crypto-club is hoping it won’t.
Even Bank of Canada’s Deputy Governor, Tim Lane, has been fairly vocal about his crypto views. He has called cryptos a “flawed” method of payment, while also adding: “The recent spike in their prices looks less like a trend and more like a speculative mania.”
The laws that be are clearly ganging-up on one side, even as more and more institutional investors and corporates are biting into the crypto market. A little while ago, CLSA’s Chris Wood wrote a Greed and Fear note making a case for shifting part portfolio allocation from gold to Bitcoin, though the exposure to gold still remained far higher.
Given the widely conflicting views and the clear divide on cryptos, even among the investor community, a tussle between the two sides (big money & believers vs regulators & naysayers) could end quite badly. That’s a big risk, and not just for cryptos.
NOT A CONTAGION RISK, BUT A RIPPLE SURELY
Let’s try and put the size of the cryptocurrency market today in context. Estimates peg the market capitalization of over 8,000 cryptos at over $1.4 trillion. Of this, Bitcoin alone is near $900 billion and the next is Ethereum with $200 billion. In contrast, the world equity market capitalization is $90 trillion, the S&P-500 market cap is $31 trillion and India’s market capitalization is $2.8 trillion. So, cryptos are still a fairly small, but not insignificant asset pool. What’s more important, though, is the pace of increase in value. The price of Bitcoin has risen from $11,000 to $48,000 in 5 months. And if it keeps rising at this pace, you can do the math on where it’s headed—Tesla’s going to end up making a big pot on its Bitcoin wager.
The point being made is that cryptos are a fast-growing market and while the collective value is relatively small compared to other asset classes, like equities, it is not so small as to be ignored.
Now, let’s look at how Bitcoin has behaved. Did you know that the S&P-500 and Bitcoin have had a positive correlation of 0.84 over the past 14 months—since January 2020? S&P-500 and crude are also positively correlated, but to a slightly lesser degree at 0.77 over the same period. What this suggests is that Bitcoin and equities tend to move in tandem, though not at the same pace. So, it is quite likely that if one of these markets is roiled, the other will feel the jitters too.
Money finds its way to several assets, but when that money gets hurt in one market, there is bound to be some pain in the others too. So any action by regulators on cryptos could not only lead to a sharp correction in their values, but will also likely cause a ripple in other assets markets, especially equities.
And crypto bubbles aren’t new. From a high of near $20,000 in 2017, the price of Bitcoin dived to near $3200 by end of 2018. But then, Bitcoin was worth much less. Will history repeat? That’s the big question.
For equity investors, though, the message is clear. Watch the crypto space closely, because what happens there can also cause a dent in your portfolio.