When cryptocurrencies took another leg lower this month following the collapse of Terra’s algorithmic stablecoin and its floating balancer token, Luna, familiar questions surfaced about potential spillover to traditional assets.
I’ve written voluminously on the subject. There was, undoubtedly, a knock-on effect from the Terra debacle. If nothing else, it was a body blow to risk sentiment at a delicate juncture.
It’s always difficult to say which way the causation runs. Do stock selloffs undermine crypto assets? Or do crypto selloffs undermine stocks? The latter question would’ve seemed absurd just a few years ago. But crypto is more widely held now. Institutional investors entered the fray, there’s a futures market, the NFT frenzy pulled in an entirely new kind of market participant and the birth of decentralized finance opened the door to borrowing, lending and leverage in every token imaginable, from the most well-known coins to the most obscure.
Crypto’s market cap at the highs in November was around $3 trillion. It’s $1.26 trillion now (figure below). That kind of wealth destruction doesn’t happen in a vacuum.
Last week, I suggested the allure of crypto riches contributed to America’s labor shortage, and thereby to the distortions bedeviling the US economy. Of course, it’s difficult to quantify such assertions. Anecdotal accounts are about the best anyone can do. Fortunately, there’s no shortage of anecdotal accounts.
For their part, Goldman doubts the crypto boom is a major contributing factor to the dearth of labor in America. “Prior academic studies have found that changes in net worth more broadly can significantly affect labor force participation, but the effects are largely driven by a reduction in labor supply of workers near retirement age,” the bank’s Joseph Briggs said.
That’s consistent with the view that the post-pandemic bonanza in stocks and home prices (figure below) impacted the labor force by changing the decision calculus for reasonably prosperous Americans considering when to stop working.
Again, what you see in the figure almost surely prompted a wave of early retirements, reducing the amount of available labor.
While it’s true that some crypto investors made enough to retire in their twenties, the vast majority didn’t. Crypto investors are disproportionately young. They’re also disproportionately male. “The labor force participation rate for younger males, who are most likely to own crypto, has already recovered to its pre-pandemic level,” Goldman’s Briggs wrote. “This pattern suggests that cryptocurrency wealth has probably played a limited role in discouraging labor supply thus far, and the recent declines in crypto prices will therefore provide a limited boost to labor supply going forward,” he added.
Relatedly, Goldman said crypto holdings account for just 0.3% of US household net worth, a rounding error when compared to equities, which comprised more than a third prior to the selloff (figure on the left below).
The read-through is that while the drop in stocks most assuredly has the potential to impact spending, the selloff in crypto probably doesn’t. On Goldman’s estimates, the stock rout likely reduced household net worth by around $8 trillion. The impact of the crypto collapse is barely large enough to show up on a stacked bar chart (figure on the right, above).
Goldman’s conclusion was simple enough. “We continue to expect tighter financial conditions will lead to a sharp slowdown in growth and spending this year, and declines in household wealth may very well incentivize some workers who left the labor market during the pandemic to return,” Briggs said. “However, any incremental impact from the recent declines in cryptocurrency prices will likely be modest.”
That’s all fair, but it’s also a bit superficial. It’s impossible to quantify these dynamics with any degree of precision. This is crypto, after all. Goldman readily admitted as much. The more important takeaway from Goldman’s piece is that increases and decreases in crypto wealth, and the accompanying impact on consumer spending (trivial or not), move in lockstep with the same ebb and flow for stocks. The figure (below) helps makes the point.
Crypto and stock prices rose together, and now they’re falling together. So, just as both were a boon to personal consumption in the aftermath of the pandemic, they’re likely to be a simultaneous drag now.
I assume the message is clear, but just in case, I’ll be unequivocal. Crypto isn’t a store of value. It’s not “money” either. And it’s not an uncorrelated hedge. It’s a volatile risk asset whose fate is intertwined with other risk assets, including and especially stocks. While crypto losses might not be material for the economy or the labor force when considered in a vacuum, nothing happens in a vacuum.
In the event of another blowup on par with Terra’s multi-billion-dollar de-par, the deleterious impact on sentiment will likely spill over into equities, absent some offsetting bullish catalyst. One could argue that if stocks are material for the economy, so is crypto. The latter can impact the former, definitely via the risk sentiment channel, and probably via all manner of other channels the vast majority of market participants don’t know exist.
In weekend remarks to Dutch television show College Tour, Christine Lagarde said her biggest concern is that people don’t understand the risks associated with crypto and may “lose it all and be terribly disappointed.” “My very humble assessment is that it is worth nothing,” she said. Lagarde mentioned that one of her sons owns crypto. “He’s a free man,” she mused.
Lagarde mentioned that her son owns crypto. “He’s a free man,” she mused.
I now have something in common with Christine Lagarde! Haha.
Lower crypto/risk assets forced people into the job market, but they are lower due to QT which will intentionally lower openings. All according to plan?
Many young adults seemed to have been influenced by crypto influencers at the peek last fall from what I can tell.
“Nothing happens in a vacuum.”
Indeed, I am regretting that I am so clumsy with typing on a smart phone.
I don’t know how to put that mini numeral when posting math functions.
Anyway. I’m thinking of CDO Squared debt packages which had “notably risen in size” during 2097-8.
Whodathunk that the collapse of those beautifully crafted derivative-based products cenedould have threatened the solvency of the regional state banks in Germany?
H-Man, tulip bulbs.
Every now and then someone says something that is very quotable. Bruce Schneier, one of the world’s leading cryptogrpahers who created the Blowfish and Twofish encryption ciphers, said the following on his blog on 20 April of this year
“It is insane to me that cryptocurrencies are still a thing.”
The red flag for me was the total absence of utility on decentralized finance platforms. I played around with a dozen of them across multiple chains with thousands of dollars each, and there’s just nothing at the bottom. It’s just a casino mixed with Ponzi dynamics. At least on Wall Street there’s something underneath it all. Even with CDOs and subprime mortgages there was something being financed. Yes, we live in a world defined by intrinsically worthless fiat, fractional reserve banking, financial engineering, self-referential government-financing schemes and financialization run totally amok, but at the bottom of it all are people trying to finance things, pay for services and buy stuff. With these DeFi platforms there’s none of that. I couldn’t discern a single purpose for their existence other than to facilitate crypto trading off centralized exchanges. But it’s just trading for the sake of it — swapping around tokens and staking them for rewards denominated in other tokens. Nothing is being accomplished. The only saving grace was that the tokens were generally all appreciating, so you could make profitable trades and earn token “rewards” which you might then convert to dollars, euros, etc. which you’d then use to transact in the real economy. But now that the tokens are all depreciating versus government-issued currencies, you don’t even have that.
To paraphrase John Paulson, cryptocurrencies are an artificially restricted supply of nothing. And ironically, technology allows for an unlimited variety of cryptocurrencies.
Looking for “treasure” we occasionally find a token worthy of a frame due to history or design, and permitting property owners tend to like them more than say a silver dime ($1.40), of the same date range.
Crypto will never even be a cool relic.
Only the various crypto inventors are safe. They got their share of the limited supply for free. Having a basis of zero may give these folks a big tax bill if and when they sell but they can never lose. Everyone else has holdings that effectively hang over a black hole. BTW, stocks share that characteristic. Founders like Bill Gates got their billions for free and can’t actually lose. The rest of us bought our stuff from someone without any guarantee of lasting value. All stocks can go to zero. I know because it’s happened to me a time or two.
Good post, I think it hits a lot of points that to me seem accurate based on personal experience. Here is some anecdotal evidence related to this topic, I’m a male in my late forties, retired because of money I made with crypto, I live better than most of my fellow countrymen and I’m thankful for it daily. I did buy early, long before this latest cycle and as such I still hold decent bags of BTC and ETH, I have taken gains along the way to buy real property because I do agree that crypto is just speculation, not a store of value, although I very much like the idea of having some wealth untied to the traditional monetary system. If Trump returns (likely) I will appreciate the ability to turn whatever stocks and cash I still have tied up in the US monetary system, turn them into BTC, put it on a ledger and walk away to El Salvador, Uruguay, Mexico or any of the other cheap but beautiful places where I can live the rest of my days and observe the caos from a distant beach. One more reason I still hold crypto, it is a call on human avarice and a put on humanity at the same time, those are bets I like.