The crypto market rises as crypto banks like Signature collapse

Financial institutions with ties to the crypto industry have had a rough few weeks. Silvergate, a main provider of banking services for crypto companies, collapsed. Silicon Valley Bank, a favorite among tech startups, failed and was taken over by the federal government, as did Signature Bank in New York, which went from backing taxi companies and Trump companies to — you guessed it — crypto.

Still, crypto markets have been on the upswing in the past week, with the trading value of Bitcoin, one of the biggest winners, jumping 14 percent to around $24,700 since Silvergate wound down. What’s up?

Experts say there are several reasons why crypto appears to be bucking the prevailing economic gloom right now, including a bet that the Federal Reserve Bank will slow its rate hikes. Another important factor is that the recent bank failures present the exact situation that crypto has long touted as a solution for – an opaque banking system where you may not be able to access all your money if a bank fails, given that the Federal Deposit Insurance Corp. -insurance covers $250,000 per depositor, per bank.

In contrast, cryptocurrencies such as Bitcoin are part of a decentralized financial system. Although crypto holdings and banks are not backed by federal deposit insurance the way traditional banks are, they are also not fundamentally tied to any government. When crypto scams fall apart or projects collapse, investors don’t have clear options to get their money back. Still, the current problems with the traditional financial system have convinced crypto boosters that this is crypto’s “time to shine.”

“Bitcoin’s strong performance in recent days has been largely driven by macroeconomic factors, particularly rising expectations of a cut in US interest rates in the coming months,” said Noelle Acheson, author of the Crypto is Macro Now newsletter and former head. of market insights at Genesis Trading, a digital asset financial services company. “This tends to favor assets with relatively high volatility, since lower prices mean easier credit, which in turn means more money chasing higher returns.”

While stocks and bonds would normally fall into that category, she said, “the deteriorating economic outlook means these are likely to be hit by earnings downgrades and credit issues. Bitcoin, on the other hand, has no earnings and no credit to worry about.”

Crypto reacts to liquidity – and central banks

Crypto’s current comeback follows a historical pattern. During previous banking crises – such as the 2013 failure of several banks in Cyprus, where depositors lost billions of dollars – crypto markets reacted positively. As March 2013 began the month of bank runs in Cyprus, Bitcoin’s value surged 178 percent, to $93, before hitting a record high that May of around $250.

(The pandemic saw a departure from this pattern, with crypto closely following the rise and fall of the stock market during the first two years of the Covid crisis.)

“I’ve always found this to be an interesting thing – whenever people get nervous about the operation of the overall banking system, especially if it could mean access to deposits could be restricted either by the bank or the government, then Bitcoin jumps in price,” Omid said Malekan, an assistant professor at Columbia Business School who teaches crypto and blockchain courses. “Because it’s censorship-resistant, no one can deny anyone access. And while the price may fluctuate, if you can’t access your dollars in a bank that’s closed, how valuable are those dollars anyway?”

Malekan was quick to note that gold also rose in price, perhaps on the expectation that the Federal Reserve might cut interest rates to reduce the shocks of the recent US bank collapses.

Crypto reacts to financial scares

During the early years of the pandemic, Malekan said, there was so much money printing and economic stimulus money in play that fears of inflation grew and the price of crypto rose. Over the past year, the Federal Reserve and other central banks have raised interest rates and tightened liquidity to curb inflation – reducing the appeal of Bitcoin. But that looks set to change with the new stress on financial markets more generally.

“The expectation now is that this banking crisis that began last week will force the Fed to have to stop tightening monetary policy and potentially start loosening it again,” Malekan said.

Acheson echoed this. She also argued that the recent bank failures have highlighted the opacity and fragility of the traditional banking system, which is likely to encourage some to think more deeply about the potential benefit of an alternative financial network.

“However, this is more of a long-term shift, supported by soaring inflation in some countries, as well as building geopolitical tensions and a growing awareness of the need for resilient stores of value,” Acheson said. “Short term, a looser monetary environment favors risk assets and we are likely to see continued inflows from macro investors.”

And this is an opportunity for crypto to reiterate its core value proposition, as proponents were quick to do. Instead of relying on centralized authorities and government bodies to enforce things, you can enforce via transparent code, according to Sunny Aggarwal, co-founder of Osmosis Labs, a decentralized crypto exchange.

“Code can enforce rules, whereas government can’t magically enforce rules. All they can do is penalize or enforce after the fact,” Aggarwal said. “But that doesn’t help when you know your money is gone, right right?”

Crypto double-edged sword

But crypto, to be fair, can cut both ways. If you tend to be “self-sufficient” with your finances, you don’t risk losing assets beyond the $250,000 FDIC limit in the event of a bank failure. At the same time, there is no one to help if a cryptocurrency evaporates, as the algorithmic stablecoin Terra did last year — leaving people with little or nothing.

Mark Lurie, CEO of Clipper, a decentralized exchange software developer, said the only reason the traditional banking system needs to periodically save is because it is a fractional-reserve system, where banks lend out more than they take in.

“This is a social construct that is only viable because the government licenses banks to print money efficiently,” Lurie said. “In crypto, lending is all overcollateralized, and so there is no need for the government to intervene if a coin falls because a run on the bank would simply empty the bank without creating contagion. Whether you see it as a worthy trade-off has a lot to do including if you are a crypto purist.”

Crypto advocates were also quick to point out that the industry still needs time to develop — even after the collapse of billion-dollar institutions like FTX.

“This is what happened to Linux – a toy operating system that for years many could not even imagine as a threat to commercial alternatives, but now runs much of the Internet and is incredibly secure, fast and reliable,” said Barney Mannerings. co-founder of Vega Protocol, a trading and derivatives scaling layer for Web3 applications.

Getting into crypto, he said, carries the same risk as being an early stage venture capitalist or angel investor — it can grow and disrupt an industry, or it can go bankrupt.

“The real risk lies in the centralized crypto services,” Mannerings said. “These have all the risks of centralized finance and more, but no real oversight. They really are the worst of both worlds. When it comes to early projects and coins, which are almost all of them at this point, people need to be realistic about what they get into.”

Thanks to Lillian Barkley for copy editing this article.