Widespread drawdowns across digital assets are sparking fears that a “crypto winter” is imminent. Turmoil in stablecoins and broader pressures on interest rate–sensitive assets have precipitated sell-offs in everything from bitcoin to NFTs to publicly traded stocks with crypto exposure. The Bitwise 100 Total Market Crypto Index, which tracks the total return of the 100 largest cryptoassets, has declined 28% since last Friday. If it finishes at the same level today, it would be the second largest weekly drawdown in the index’s five-year history.
For more on digital assets, please see Sean Duffin, “Crypto Considerations,” Cambridge Associates LLC, September 2021, and Joe Marenda, “Charting New Waters: What Pension Plan Sponsors Should Know About Digital Assets,” Cambridge Associates LLC, March 2022.
At the center of the crypto rout over the past few days is the destabilization of a prominent stablecoin, TerraUSD, which broke its peg to the US dollar and was trading at a 60% discount to the greenback as of this writing. Certain stablecoins are intended to be pegged to the dollar, offering investors a simplified way to transact on crypto exchanges. They are generally backed by currencies or other tangible assets. However, some stablecoins, such as TerraUSD, do not hold any form of collateral and instead aim to keep their peg using financial engineering and algorithms. The collapse in TerraUSD initially caused fears of wider contagion among stablecoins, particularly Tether, which initially fell to $0.95 before stabilizing.
The rout in digital assets comes amid a downturn in equity and bond prices. These assets have declined as investors have been confronted with higher-than-anticipated levels of inflation and increased interest rate hike expectations. This negative market sentiment has weighed on the returns of highly speculative assets like cryptocurrencies, which generally do not offer cash flows. In fact, the 90-day correlation between bitcoin and the NASDAQ 100 Index just reached an all-time high of 0.62, surpassing the prior peak correlations that coincided with COVID-19 market swings in 2020.
Overall, investors should not be surprised by the recent volatility across digital assets. This is an industry that has experienced astonishing booms and painful crashes in the past decade. Digital assets (particularly liquid tokens) are extremely volatile, and there will be many losers from an investment standpoint as the space continues to evolve. Despite this, we are enthusiastic about the future applications of blockchain technology and its potential to transform business models and operating structures.
Sean Duffin, Investment Director, Capital Markets Research