Why Bitcoin and other cryptocurrencies are falling like a pack of cards

The global stock market weakness has spilled over to the cryptocurrency world, with Bitcoin and other digital currencies falling sharply and raising fears that it could potentially even threaten the financial system at large. 

As of Wednesday morning, the global crypto market cap was down nearly 18% since Tuesday, and had shrunk to $1.29 trillion. On Tuesday, it was down nearly 8% over the previous 24-hour period. 

Almost all the top 10 cryptocurrencies are down significantly this week, with Bitcoin price crashing to $27,500 levels, the lowest since June 2021. This is a steep decline since April 19, when Bitcoin was at $41,532 levels.

Having said that, Bitcoin remains the dominant cryptocurrency, making up for more than 40% of the global crypto market by asset size. 

But why are global cryptocurrencies crashing like a heap of cards?

Experts say that this is because of a broad sell-off in the wider capital markets, as global markets are extremely volatile and there is a sense of extreme fear. This has led even institutional investors to sell their crypto assets in bulk, further exacerbating the crash. 

“Due to a broad sell-off, BTC (bitcoin) prices dropped below the $30,000 level for the first time since July 2021, while ETH (Ethereum) prices stood at $2,319. The Crypto Fear and Greed index was in the ‘Extreme Fear” zone, a sign that investors were too worried and were selling their holdings to minimize losses,” a report in The Financial Express newspaper cited Darshan Bathija, CEO and co-founder of Vauld. 

The report further cited him as saying that the fall shows bitcoin’s correlation with the S&P Index, and market participants trying to reduce their exposure to risk. 

So, how much are institutional investors selling?

One case in point is that of Luna Foundation Guard, which has decided to sell $750 million of its bitcoin reserves citing uncertain macroeconomic conditions in the market. 

Moreover, inflation and the fears of a full-blown recession are also leading investors to sell their crypto assets. 

Industry experts say the global financial markets are battered by rising inflation and the Russia-Ukraine war, and a highly volatile situation in Sri Lanka. The Indian rupee has fallen to a record low, which will make imports costlier and will have a significant impact on the financial markets.

“The above factors are putting tremendous pressure on the crypto market as well and we are witnessing a large sell-off by the investors to park the cash for better times,” said Shivam Thakral, CEO of BuyUcoin, according to the FE report cited above.

How big really is the global crypto market?

In November, the most popular cryptocurrency, bitcoin, hit an all-time high of more than $68,000, pushing the value of the crypto market to $3 trillion, according to CoinGecko. That figure was $1.29 trillion on Wednesday.

Bitcoin accounts for nearly $600 billion of that value, followed by Ethereum, with a $285 billion market cap.

But do global crypto markets compare with the equity markets?

Not really. Crypto markets are still relatively small as compared to equity markets. The US equity markets, for example, are worth $49 trillion while the Securities Industry and Financial Markets Association has pegged the outstanding value of US fixed income markets at $52.9 trillion as of the end of 2021.

So, could a crash in crypto valuations endanger the overall financial system?

While the overall crypto market is relatively small, the US Federal Reserve, Treasury Department and the International Financial Stability Board have flagged stablecoins—digital tokens pegged to the value of traditional assets—as a potential threat to financial stability, according to a Reuters report.

Stablecoins are mostly used to facilitate trading in other digital assets. They are backed by assets that can lose value or become illiquid in times of market stress, while the rules and disclosures surrounding those assets and investors' redemption rights are murky.

The Reuters report cited above further notes that this could make stablecoins susceptible to a loss of investor confidence, particularly in times of market stress. 

With more companies' fortunes tied to the performance of crypto assets and traditional financial institutions dabbling more in the asset class, other risks are emerging, say regulators. In March, for example, the Acting Comptroller of the Currency warned that banks could be tripped up by crypto derivatives and unhedged crypto exposures, given they are working with little historical price data.