Bitcoin surges during a financial crisis

In the wake of the explosion of high-profile Silicon Valley Bank, cryptocurrency is rising in price. After all, cryptocurrency is generally among the riskiest trading vehicles, usually backed by no hard assets or cash flow from an underlying company, unlike stocks.

So you can expect the cryptocurrency to plummet when a crisis of confidence hits the markets. Instead, leading crypto Bitcoin rose after the announcement that the US government insured virtually all deposits in the troubled California bank and depositors would be whole.

Here’s why Bitcoin is surging amid the crisis, and why an asset-backed stablecoin is falling.

Bitcoin Rises After Bank Explosion

As the bellwether for the sector, Bitcoin surged around 18 percent following news that regulators insured all depositors at Silicon Valley Bank and created a fund to bolster others across the United States. What happens to rising crypto prices? In a word: interest.

Cryptocurrency is a risky asset that trades on changes in the future direction of interest rates, in the same way that many growth stocks do. When prices rise, traders move away from risky assets, but when prices fall, they tend to move into riskier assets. Now they expect the fiery pace of the Fed’s rate hikes over the past year to slow, if not stop altogether.

“We believe this is actually a recognition of the underlying challenges we see facing US monetary policy,” said Gabriella Kusz, CEO, Global Digital Asset & Cryptocurrency Association.

The Federal Reserve has pursued a policy of rapidly raising short-term interest rates to curb inflation, which had recently been at multi-decade highs. Rising short-term interest rates have increased the financing costs of the banks, weakened bond prices and put a lid on share prices.

Crypto supporters see Bitcoin’s move as a sign of stability and growing acceptance.

“As players begin to understand the role that US monetary policy, inflation and interest rate hikes have played in the current challenges in the banking sector, you are likely to see a move towards Bitcoin and other forms of crypto as a reflection of their potential value as a hedge and alternative store of value in such times, says Kusz.

But Bitcoin’s move may seem paradoxical, as investors seem more nervous and inclined to run to “safe haven” assets such as US Treasuries in a crisis. After all, Bitcoin is a risky asset that is not backed by hard assets or cash flow from an underlying entity, unlike stocks and bonds.

Crypto assets have been associated with a number of high-profile bankruptcies recently, including those of Celsius and BlockFi, as well as the apparent fraud of crypto exchange FTX. Banks involved in fintech innovation such as Silvergate and Silicon Valley Bank have also been caught.

Key stablecoin USD Coin under pressure

Another cryptocurrency was under pressure over the weekend, a so-called stablecoin called USD Coin, whose goal is to peg its value to the US dollar and maintain a value of $1. Such stablecoins are not meant to fluctuate in price, unlike almost all other cryptocurrencies. Typically, stablecoins maintain some hard assets like actual dollars to back their value.

Following the shutdown of Silicon Valley Bank, USD Coin fell in value to less than $0.88 over the weekend, a dangerous situation that could lead to a run on the cryptocurrency. Traders speculated that, after an initial statement by regulators guaranteeing full returns only to depositors with less than $250,000, the stablecoin could come under further pressure.

“USD Coin fell off the hook because less than 10 percent of its backing was held in Silicon Valley Bank, and it was unclear whether the money would be returned or not,” said Aaron Rafferty, co-founder of BattlePACs and CEO of StandardDAO.

“Since Friday, however, the federal government and President Joe Biden have confirmed that depositors will have 100 percent certainty in redeeming their money, so the crisis was averted … for now,” he says.

Since the fall, USD Coin has almost regained its full value, trading just shy of the $1 peg.

What should investors know about cryptocurrency?

It is important that those thinking about putting their money into cryptocurrency understand the risks involved in doing so, as it can be easy to overlook the risks and how volatile the crypto markets are.

The volatility of cryptocurrency markets can make even traditional stock markets look tame by comparison. Even so-called safe assets like stablecoins can move significantly, as traders saw in 2022 with the spectacular explosion of the UST stablecoin. When trading volatile assets, inexperienced traders can easily make mistakes and let their emotions get the best of them.

But volatility is only part of the risk inherent in cryptocurrency. A more important risk is the lack of intrinsic value in most cryptocurrencies. They are not backed by the assets or cash flow of an underlying company, meaning the only thing holding them up is the sentiment of other traders. In contrast, stocks are backed by the assets and cash flow of the specific company.

This lack of fundamental support means that the only way to make money from crypto is to trade it to someone else who is even more bullish about it. This is what is known among investors as “the greater fool theory of investment”, which is why legendary investors like Warren Buffett and Charlie Munger won’t touch it, and have even gone so far as to say that it should be banned.

The bottom line

As the cryptocurrency market ebbs and flows on short-term drivers like the Silicon Valley Bank crisis, investors should be aware of cryptocurrencies’ lack of underlying value. Wealth is built over time through sound long-term investment, not by playing the lottery.