RISE WITH FIS

Crypto Winter: Why regional and community banks should stay the course

Nicole Pienkos | SVP, Group Executive, Regional Banking

July 25, 2022

Now more than ever, people are making a lot of assumptions about cryptocurrency, or crypto. During periods of intense market volatility, many novice investors assume that cryptocurrency is unsafe. Too risky. The technology is too new and unproven. Their value is not backed by anything solid. Bitcoin, Dogecoin – what’s the difference? They are likely to make the same false assumptions about stocks and just about any other type of investment as they plummet in value in an economic downturn.

Regional and community banks looking to launch buy/sell/hold crypto products and services may be growing anxious under current market conditions. But this anxiety is misplaced. History has demonstrated time and again that, in aggregate, economic downturns are temporary setbacks. For savvy investors, they present a tremendous opportunity to increase holdings for significant long-term growth. They key is knowing which investments provide desirable upside and acceptable risk. Cryptocurrency is no exception. Regional and community banks must be equipped to help their customers capitalize.

The human element

If only the stock market were as predictable as people, investors would never miss. For centuries people have demonstrated enormous collective power to drive markets to scary heights and devastating drops. Just because a lot of people are investing in something with wild enthusiasm, that does not make it a good investment.

In fact, skepticism is wise under these circumstances. At least a few people who watched Super Bowl LVI took Matt Damon’s advice and invested in crypto. At least a few of these may have invested in LUNA, which at its height had a combined market value of more than $60 billion. Within a 48-hour window, the LUNA crypto token crashed from $120 to $0.02 – a 99.9% correction. From there, the price continued to plummet, the decimal moving farther and farther left. Fractions of a penny. Billions of dollars wiped out within days.

It would be easy to assume this could happen to any cryptocurrency on the market, and many investors made this assumption, wiping out more than $300 billion in combined value across all cryptocurrencies including giants Bitcoin and Ethereum.

As mania-driven buys do not always indicate a good investment, panic-driven selling does not always indicate a bad one.

Not all crypto is created equal

What is the difference between LUNA and Bitcoin? There are many, but perhaps the most important difference is this: Bitcoin is a regulated cryptocurrency, and LUNA is an algorithmic stablecoin. While typical stablecoins use a centralized asset-backed model, LUNA and other algorithmic stablecoins are a completely synthetic asset, attempting to peg their value to the value of something else. This construct is unreliable and, in the case of LUNA, unsustainable.

The key differentiator of Bitcoin, on the other hand, is scarcity. Bitcoin (BTC) is capped at 21 million. This scarcity drives demand, which, if all things remain equal, preserves purchasing power regardless of the dollar.

However, investor behavior this year indicates that cryptocurrency is perceived as a risk asset above all else. Thus, all things are not equal in terms of demand stability or even growth. Buyers have put cryptocurrency in the same bucket as the stock market, and, as such, it is susceptible to the same triggers, specifically inflation, interest rates and recession. As interest rates increase to stave inflation, investors are driven toward liquidity. This creates supply, which drives down the price.

Here are three snapshots to demonstrate this:

  • When inflation reached 40-year highs in late 2021, BTC fell from an all-time high of $61k to $47k by end of 2021.
  • When the Fed indicated that it would raise the interest rate by half a percentage point on May 31, Bitcoin fell in concert with the stock selloff.
  • When talks and confirmation of a federal rate hike of 75 basis points caused the stock market to drop significantly (the Dow lost 3,160 points from June 8 to June 16), BTC fell from $31k to $22k. Other currencies suffered more drastic declines in value.

While it is true that BTC has lost enormous value in recent months, it is nonetheless behaving as reasonably expected in the current economy. These cryptocurrencies have mastered the key ingredients for sustained success: decentralized decision-making, utility and regulatory maturity.

Here are just a few current circumstances that are likely good indicators of the future:

  • Bitcoin is borderless and digital, making it perfectly suited to globalization.
  • Bitcoin holdings among long-term investors are increasing during this downturn, indicating that many are taking the opportunity to acquire at a lower price while simultaneously promising a faster positive price correction than the stock market due to supply and demand.
  • Only about 12% of crypto is held on exchanges, further proof that most investors are not looking for fast cash or liquidity but instead riding the dip for long-term gain.

Cryptocurrency is currency

Though some mistakenly believed cryptocurrency would replace traditional fiat currencies as something different, immune from market forces and a good hedge against inflation, the opposite has proven true. Cryptocurrency is, ultimately, just currency. Bitcoin runs alongside the financial markets, subject to the same forces.

As stated before, history has shown time and again that even the most severe economic downturns are temporary. The long-term trajectory of the markets is always climbing. This is not the first major recession that the crypto markets have endured. Regional and community banks would be wise to consider the current moment another “stress test” on the path to future growth and bullish investing.