Does the recent cryptocurrency crash pose a threat to the financial system?

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Since the Covid-19 pandemic, cryptocurrency adoption has increased significantly. Growing in both value and popularity, the cryptocurrency market has become submerged in the traditional financial system. In light of the recent crypto market crash, many in the broader economy have been asking whether this will have any effect on the larger global financial markets and be a threat to financial stability across all asset classes. Let’s find out. 

The Crypto Market Crash of 2022

After weeks of mediocre market performance, an unsuspecting crash caused the markets to further weaken at a rapid pace. The Terra network, operating both LUNA and UST (the stablecoin, TerraUSD) lost millions of dollars in a matter of days causing both institutional and retail investors to take notice.

The LUNA network lost a significant amount of value which resulted in the market cap going under that of UST. The LUNA coin was designed to hold the reserves which peg UST to the US dollar, so once these reserves dipped below that of the market cap of UST it became clear that the network did not hold enough reserves to support the stablecoin. Both cryptocurrencies then experienced nose dives in their value, LUNA going from highs of $119 to lows of $0.0003. 

This and the recent Celsius drama had a knock-on effect on the rest of the market, causing most crypto assets to make double-digit losses, including the Bitcoin market. In a matter of weeks the entire crypto market went from being valued at $1.294 trillion to $968 Billions. Sizable losses but a vast contrast from the highs of nearly $3 trillion just seven months ago. 

Crypto Vs Traditional Markets

While the cryptocurrency market is still relatively young, it has made considerable gains over the last few years. When compared to more traditional markets, though, it might be likened to a drop in the ocean. For example, the U.S. equity market is worth $49 trillion while the derivatives market is believed to be valued at over $1 quadrillion and the bond market at $119 trillion. 

A $3 trillion market value, while impressive for an asset class just over a decade old, doesn’t hold too much weight in comparison.

Does The Crypto Crash Pose A Threat To Greater Financial Stability?

Considering these values, the cryptocurrency market makes up only a very small percentage of the world’s wealth. However, the international Financial Stability Board, the U.S. Treasury Department, and the Federal Reserve recently flagged stablecoins as a potential threat to the financial stability internationally. 

Stablecoins are digital currencies pegged to a fiat currency, where the operating company is required to hold the equivalent amount of the fiat currency in reserve in order to maintain its 1:1 value. This is the case for both USD Coin (USDC) and Tether (USDT). 

This concern is likely to be heightened following the market crash of UST, however, most of the other stablecoins are fiat-backed as opposed to being backed by an algorithm. 

In short, no, a crypto crash is unlikely to affect the broader financial market but rather individual and institutional investors. As witnessed in the past, markets fluctuate and all crypto winters have been succeeded by bull runs.