The trouble with crypto and why GBP is weighed down by “good” data
The biggest move on Wednesday is in the crypto market. Cryptocurrencies have fallen sharply on Wednesday as fears have started to grow that Chinese regulators will intensify their crackdown on financial instiututions that use digital currencies. Bitcoin is down 20% so far on Wednesday, and other digitial currencies have followed suit, including Ethereum, which is considered more stable than bitcoin. Major stock indices are also lower for yet another day. The decline in major stock indices, which is averaging about 1.5% for the European indices, US S&P 500 futures are predicting a 1.3% decline for US stocks at the open, suggests that risk sentiment towards stocks is impacted by the crypto market.
The People’s Bank of China, China’s central bank, said on Wednesday that crypto currency is “not a real currency” and “should not” be used as a currency in the market. It also said that the recent surge in crypto currency prices is speculation and cannot be sustained. This is perhaps the most vocal criticism from a major central bank against crypto currencies, even the Fed has not been as blatantly anti- crypto as the PBOC. But perhaps a sign of how important China’s central bank is to the global economy, its outrage over crypto currency usage has been heeded by the market. It has been a difficult month for crypto currencies, after Tesla founder Elon Musk reversed course and said that the EV maker would no longer accept bitcoin as payment for its vehicles. Bitcoin is currently trading around the $30,000 mark and could be in for deeper falls once the US comes on board this afternoon.
The trouble for crypto currencies is twofold. Firstly, greater regulatory scrutiny, and secondly, its mode of use. Looking at regulation first, it seems likely that other central banks will subject crypto currencies to greater scrutiny especially as more institutional and retail investors are involved with digital currencies. Added to this, Tesla ditched Bitcoin as a method of payment due to environmental concerns – bitcoins require huge amounts of electricity to mine. When Tesla said that they would accept bitcoin as payment the crypto community rejoiced, however, the confluence of regulatory concerns along with Tesla’s news has weighed heavily on Bitcoin, and it is now back at its lowest level since February 2021. The selloff in crypto currencies has also dragged down securities that rely on the price of digital currencies such as Coinbase, the digital currency exchange, which was down nearly 10% in pre-US market trading.
There are some lessons to be learnt from the sharp selloff in crypto currencies this week. Firstly, the extreme volatility experienced by cryptocurrencies can seep into the broader market, secondly, blue chip indices and big global FX and commodity players have nowhere near the levels of volatility that are experienced by the crypto market. Lastly, crypto has its own risk factors that are distinct from broader markets, for example, regulatory risks and concerns about big consumer companies, such as Tesla, deciding to ditch crypto for environmental reasons. These risk factors will need to be added to price models in the coming days and weeks, which could limit some of the fervour around crypto, and which is part of the normal life cycle of a developing asset class, albeit a massive one like the crypto currencies.
Will people really ditch crypto and will its price continue to fall? We tend to think not. Although it has some major issues and its valuation was too high prior to the recent sell off, we still think that it remains an attractive investment proposition for some. For example, US regulators have made it easier for institutions and retail investors to trade crypto in recent years, and this will continue to act as a draw to this alternative asset class. Also, the extra scrutiny from regulators and corporates could have a long-term positive effect on crypto. Firstly, it could limit enthusiasm on the upside, and stop crypto currencies from reaching absurd valuations like we have seen recently with dogecoin. If this happens, then it could smooth some of the volatility in crypto currencies, that makes some institutional investors and central banks like the PBOC nervous. While this may be a pipedream right now, it is something to think about for the future. For example, while I have written this report, Bitcoin/ USD has risen some $5,000 as the market tries to settle on an appropriate price following the news from the PBOC. Is this a sign that there is willing buyers out there? Or is such volatility a sign that this is a dysfunctional market?
For now, we will have to see. Bitcoin and the crypto community is still having a horror of a day, and until the price settles down, we think that the bias will be for lower risk assets. This will mostly impact stocks and commodities, but it may also have an impact on the FX market, where the JPY and other safe haven currencies are rising. GBP/USD fell sharply today alongside other risky assets, even though UK inflation was stronger than expected. However, it is starting to recover ahead of $1.41. Gold is also having a moment and continues to make gains on Wednesday. It is currently up 0.4%. While it is much less volatile than bitcoin, and is not the perfect hedge for crypto currencies, its attraction compared to crypto cannot be denied especially after Wednesday’s price movements. .