The virtual currency market ‘evaporating’ affects the traditional financial system?

Compared to the most recent policy tightening cycle of the US Federal Reserve (FED) in 2016, the virtual currency market is now much larger in size, raising concerns about the impact of it with the global financial system.

Cryptocurrency Market Size

According to CoinGecko, in November 2021, when the leading virtual currency – Bitcoin reached an all-time high of $69,000, the entire cryptocurrency market cap fell to about $3 trillion. More than six months later, that number has dropped to $1.51 trillion.

Bitcoin is still the largest contributor by market capitalization with nearly 600 billion USD, followed by Ethereum with 285 billion USD.

Although cryptocurrencies have had a boom, the scale is generally relatively small. For example, the US stock market is valued at $49 trillion, while the Securities and Financial Markets Association identifies the value of fixed income markets. and bonds) reached $52.9 trillion by the end of 2021.

Who owns and trades cryptocurrencies?

At first, cryptocurrency was just a phenomenon for small individuals, but the interest of institutions from exchanges, companies, banks, hedge funds and mutual funds to the asset class This is increasing over time.

Although it is difficult to give exact data on the ratio of retail investors to institutions in the virtual currency market, according to Coinbase, the world’s largest cryptocurrency exchange, the fourth quarter of 2021, the Institutional and retail investors are sharing about 50% of the assets each on the platform.

Specifically, Coinbase’s institutional clients made $1.14 trillion worth of transactions in 2021, compared with $120 billion a year earlier.

The majority of Bitcoin and Ethereum in circulation are held by a small number of investors. October 2021, research by NBER (National Bureau of Economic Research) shows that about 10,000 Bitcoin investors, both individuals and institutions, are holding one-third of the coins on the market and have 1,000 investors own 3 million Bitcoins.

According to research by the University of Chicago, nearly 14% of Americans have invested in digital assets as of 2021.

Could a virtual currency crash damage the financial system?

Although the virtual currency market as a whole is relatively small, the Federal Reserve, the Treasury Department, and the International Financial Stability Board all warn against stable-coins, the crypto-token anchoring value to traditional assets, can become a threat to the stability of the financial system.

Stable-coins are mainly used to facilitate other digital asset transactions. They are backed by assets that can lose value or become illiquid during market stress. In addition, the rules of security and management around these assets and investor redemption rights are not clear.

Therefore, stable currencies will become a factor in weakening investor confidence during market turmoil.

For example, TerraUSD, a stablecoin pegged 1:1 to the USD, is using Bitcoin as a backup currency in case the currency goes into crisis. On May 11, TerraUSD plunged without braking when losing nearly 80% of its value.

While TerraUSD maintains an exchange rate to USD through an algorithm, with stablecoins backed by assets such as cash or commercial paper, this impact could well spill over into the traditional financial system.

Vinh Ngo (According to Reuters)