The collapse of cryptocurrency appears to be underway. Over the past six months, the value of Bitcoin alone has fallen almost 50% – and could be set to fall even further. Will this lead to further-reaching implications?
Since November 2021, over $2trn in value has been wiped out. In the opinion of ACA Global, a more mature regulatory framework would have protected at least some investors as exchanges and leverage proliferated in recent years.
With the collapse of cryptocurrency gathering pace, the crypto markets – ACA claims – are vulnerable to contagion. “Extensive leverage, with coin deposits collateralizing and collateralising multiple rounds of loans to fund speculative coin purchases, create the potential for cascading margin calls”
The company added that some cryptocurrency exchanges have chosen jurisdictions that impose little or no regulatory oversight, which much of the ecosystem’s infrastructure being dependent on stablecoins that may have collateral deficiencies or liquidity mismatches.
ACA also cited the lack of regulation in the crypto environment which has led to the return of many ‘old frauds’ that had mostly been stamped out, including front running, ponzi schemes, price manipulation through washing trading and outright theft of assets.
ACA said, “The extent to which dislocations in the crypto markets could impact more traditional asset classes is a question both policy makers and investors are looking to understand. Potential avenues for further spill through could include heightened recession risks as cryptocurrency losses impact consumer spending, and potential losses on bank loans to crypto miners, collateralized by equipment that has suddenly become less valuable. Contagion risks are almost always obvious in hindsight but can be difficult to identify in the moment.”
In the opinion of the firm, cryptocurrency poses more contagion risks to traditional finance than in prior years – adding ‘if cryptocurrency advocates ever achieve their aims of mainstream adoption for commerce or investing, then contagion risks will rise exponentially’. The current potential for cascading failures within the cryptocurrency ecosystem highlights the need for meaningful regulations of exchanges, leverage, and stablecoins, ACA added.
Market collapse implications
Many in the industry and in government are fully aware of the risks of cryptocurrency collapse and its need for regulation. Earlier this year, US Treasury Secretary Janet Yellen testified in front of a Senate Committee that digital assets ‘may pose risks to the financial system, and increased and coordinated regulatory attention is necessary’.
President Biden also previously signed an Executive Order calling for a ‘comprehensive approach’ to digital asset policy.
ACA highlighted that questions still remain as to who will regulate the cryptocurrency market. It cited how in early June this year, a bipartisan bill was introduced in the US Senate to allocate primary regulatory oversight responsibilities of cryptocurrency to the Commodity Futures Trading Commission.
The company said it anticipated regulatory trends would make it more difficult for exchanges in less regulated jurisdictions to access investors and capital in more regulated jurisdictions, as well as there being limitations on leverage, including net capital requirement for cryptocurrency exchanges. ACA also anticipates improved stablecoin transparency and collateral quality and one or more financial regulators having a robust anti-fraud mandate, with strong powers, staffing and funding.
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