How a crypto crash could spread to Treasury bonds and other fixed-income securities
By Mark Hulbert
Bitcoin and other cryptocurrencies could be hazardous to your wealth -- even if you never invest in them
A cryptocurrency crash could have repurcussions well beyond crypto itself. Contagion could spread to the fixed-income market, and then to other financial markets as well.
That's the investment implication of a new study out of Yale University that began circulating in academic circles earlier this month. Entitled "How the cryptocurrency market is connected to the financial market," the study was conducted by Sang Rae Kim, a doctoral candidate in Yale's economics department.
The study's findings are surprising, since there was no obvious contagion in early May from the collapse of TerraUSD /LUNA to the fixed-income market generally. This led many who had been worried about possible contagion to breathe a sigh of relief.
We shouldn't be breathing easier, according to the new study. The TerraUSD-LUNA debacle tells us nothing about the impact of a sudden decline in bitcoin or other large cryptocurrency, Kim told me in an interview.
To understand what the study found, it's helpful to distinguish between the different kinds of cryptocurrencies:
The channel that contagion would follow from, for example, a bitcoin crash to the financial markets generally would be via collateralized stablecoins, Kim told me. Three-quarters of the time when investors buy or sell a fiat cryptocurrency, a stablecoin is on the other side of the transaction. And Tether and USD Coin together account for more than 80% of the total market capitalization of all stablecoins.
Specifically, the causal chain would operate as follows:
This causal chain isn't just hypothetical. Kim closely analyzed daily changes in the market caps of cryptocurrencies, collateralized stablecoins, the commercial paper market, and commercial paper and Treasury yields, and found that they are correlated to each to a statistically significant extent.
To illustrate the magnitude of the contagion, Kim estimated what could happen to commercial paper and Treasury yields if the three largest fiat cryptocurrencies suffered a one-day decline in the 5% to 10% range. That's big, but hardly rare. If cryptocurrency holders were to panic, which by no means is out of the question, these fiat cryptocurrencies could experience a much bigger one-day decline.
Nevertheless, Kim estimates that a 5% to 10% daily decline in the largest cryptocurrencies would cause commercial paper yields the next day to fall 20 basis points and Treasury yields by 17 basis points -- with their prices rising by a corresponding extent. Those are big changes for a single day, and we should all sit up and take notice.
Why no contagion from TerraUSD/LUNA?
Kim's analysis therefore helps us understand why there was no contagion from the collapse of TerraUSD and LUNA: Since no financial market assets were being used to collateralize these algorithmic stablecoins, their collapse had little impact beyond those investing in them.
This isn't Monday morning quarterbacking to point this out. In his research, which Kim completed before the TerraUSD/LUNA fiasco, he found no statistically significant correlation between changes in market cap of algorithmic stablecoins and the yields on commercial paper and U.S. Treasurys.
The bottom line? The financial markets' muted reaction to the collapse of TerraUSD and LUNA provides false comfort. Like it or not, we're all vulnerable to a crypto crash.
Mark Hulbert is a regular contributor to MarketWatch. His Hulbert Ratings tracks investment newsletters that pay a flat fee to be audited. He can be reached at firstname.lastname@example.org
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(END) Dow Jones Newswires
May 28, 2022 05:20 ET (09:20 GMT)
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