Cryptocurrencies React to Financial Crisis – What’s Going On?

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As the high-profile Silicon Valley Bank disaster plays out, the value of cryptocurrency is skyrocketing. Crypto is usually considered one of the riskiest investment opportunities since it is usually not supported by physical assets or incomes of its underlying organization, unlike stocks.

Therefore, one might assume that when a crisis of confidence enters the market, crypto prices would drop significantly. Surprisingly, after the announcement that the U.S. government would insure nearly all deposits in the troubled California bank, Bitcoin saw an 18 percent rise.

What Causes Bitcoin Surge During a Financial Crisis?

The key factor behind the crypto surge is interest rates. Cryptocurrency is a delicate asset that depends on the changes in future rate of interest, much the same way as growth stocks do. When rates enhance, traders often move away from risky assets, however when rates fall, they tend to invest in riskier assets.

Gabriella Kusz, CEO of Global Digital Asset & Cryptocurrency Association, claims that this is an acknowledgement of the issues that U.S. monetary policy is facing. The Federal Reserve has been attempting to curb inflation, which reached a multi-decade high recently, by raising short-term interest rates swiftly. This has raised the funding costs of banks, hurt bond prices and hindered stock markets.

Crypto supporters are looking at the Bitcoin rise as a sign of its steadiness and increasing approval. Kusz says that as people start to recognize the role that U.S. monetary policy, inflation and interest rate increases have had on the present banking sector issues, they are likely to move towards Bitcoin and other forms of crypto as a representation of their potential value as a protective asset and alternative store of value during such times.

But Bitcoin’s reaction may appear paradoxical as investors appear to be more anxious and likely to move to “safe haven” assets like U.S. government bonds in a crisis. After all, Bitcoin is a fragile asset without any physical assets or cash flow of an underlying entity, unlike stocks and bonds.

Why Is USD Coin Under Pressure?

Another kind of cryptocurrency, called stablecoin USD Coin, is under pressure during this financial crisis. This crypto is meant to peg its value to the U.S. dollar and maintain a value of $1. Stablecoins do not usually fluctuate in price, unlike most other cryptocurrencies and are typically backed by some hard assets such as actual dollars.

After the closure of Silicon Valley Bank, USD Coin dropped to less than $0.88 over the weekend, a critical situation that could result in a run on the cryptocurrency. Investors were speculating that after the initial statement from regulators guaranteeing a full return only for depositors with less than $250,000, the stablecoin might experience more pressure.

Aaron Rafferty, co-founder of BattlePACs and CEO of StandardDAO, explains that the USD Coin decreased its peg because only about 10 percent of the backing was held in Silicon Valley Bank, and it was not sure if that money would be returned. However, the federal government and President Joe Biden have since confirmed that all depositors will get 100 percent security when reclaiming their funds, so the crisis has been averted, so far.

USD Coin has nearly recovered its full value since then and trades just slightly below its $1 peg.

What Should Investors Understand About Cryptocurrency?

It is fundamental that people considering investing in cryptocurrency are aware of the risks involved, since it can be simple to overlook the risks as well as how volatile crypto markets can be.

The instability of crypto markets can make even traditional stock markets seem mild in comparison. Even so-called safe assets such as stablecoins can move significantly, as traders saw in 2022 with the spectacular failure of the UST stablecoin. When trading volatile assets, novice traders can easily make mistakes and let their emotions take over.

But volatility is only one part of the risk inherent in cryptocurrency. A much more important risk is the lack of inherent value in most cryptocurrencies. They are not supported by any assets or cash flow of an underlying organization, meaning that the only thing keeping them up is the opinion of other traders. On the other hand, stocks are supported by the assets and cash flow of the specific company.

This absence of fundamental backing implies that the only way to make money on crypto is to trade it to someone else who is more positive about it. This is what is known among investors as the “greater fool theory of investing”, which is why famous investors such as Warren Buffett and Charlie Munger will not touch it, and have even gone as far as suggesting that it should be prohibited.

Summary

While the crypto market is affected by short-term drivers such as the crisis at Silicon Valley Bank, investors should keep in mind the lack of underlying value of cryptocurrencies. Wealth is created over time by prudent long-term investing, not by gambling.

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