Examining crypto Wall Street ties: The good and the bad

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On August 5, 2024, a series of opposing political and economic news triggered a major decline in both the US and Asian markets. This was followed by a sharp decline in the cryptocurrency market, with its total capitalization falling by 12% in 24 hours. The widespread stock sell-off, driven by concerns about the economic outlook and rising geopolitical tensions, intensified market volatility and was reflected in the cryptocurrency market, weakening investor confidence in general.

The recent market turbulence is a stark reminder of the growing interdependence between cryptocurrency and traditional financial markets. As cryptocurrencies gain mainstream acceptance and attract significant institutional capital, the lines between these markets are becoming increasingly blurred. While beneficial in many ways, this interconnectedness also means that tradfi shocks reverberate more intensely and quickly across the crypto space.

The double-edged sword of corporate capital

The crypto industry has undoubtedly seen a significant influx of institutional capital in recent years. However, this development has been a double-edged sword. On the one hand, the entry of institutional investors has enabled the mass adoption of crypto and contributed to the maturation of the industry. On the other hand, it has also created a stronger correlation between the crypto and tradfi markets. When the stock market crashes, the crypto market usually follows suit.

Institutional capital has lent legitimacy and credibility to the cryptocurrency market. Financial giants and large investment funds have entered the space, injecting significant liquidity and strengthening the sector’s image as a viable investment option. This flow has facilitated the development of sophisticated financial products and services such as crypto futures, options, and ETFs that integrate cryptocurrencies into the broader financial ecosystem.

But this integration comes with its own set of challenges. The increasing involvement of institutional investors means that the crypto market is no longer isolated from the broader economic and geopolitical forces that drive traditional markets. When there is a large stock sell-off, as we have recently witnessed, ripple effects are felt across the crypto market due to this interconnectedness, which increases the crypto market’s volatility and susceptibility to external shocks.

Monetary policy: The invisible hand that shapes crypto prices

Monetary policy changes, especially interest rate changes, have a profound effect on cryptocurrency prices. Recent bets on US interest rate cuts have sparked discussions about their potential positive impact on the cryptocurrency market. Historically, monetary tightening has presented significant challenges for the crypto industry. Recent significant liquidities in crypto betting serve as a stark reminder of this dynamic. When interest rates rise, liquidity tends to tighten, leading to a squeeze on the availability of capital for investment in riskier assets like cryptocurrencies.

When central banks cut interest rates or engage in quantitative easing, the resulting liquidity surge can flow into higher-risk assets, including cryptocurrencies. This capital influx can push crypto prices higher as investors seek better returns from traditional assets. Conversely, when central banks tighten monetary policy to curb inflation or stabilize the economy, reduced liquidity and higher borrowing costs can lead to a retreat from riskier investments, including crypto.

The recent market crash has highlighted this monetary policy effect. As central banks around the world grapple with inflationary pressures and the need to stabilize their economies, their policy decisions have direct and immediate consequences for the cryptocurrency market. Investors need to be attuned to these developments and understand how changes in monetary policy can impact market dynamics.

Inevitable crises and why we need to be prepared

Despite the challenges, the crypto industry requires institutional capital to sustain its growth trajectory. Institutional investments provide financial resources, legitimacy, and broader acceptance of cryptocurrencies as a viable asset class. However, this reliance on institutional capital means that the crypto market is still increasingly affected by the same factors that drive tradfi markets. This growing connectivity highlights the inevitability of crises like the one we are currently experiencing, and also presents an opportunity for the crypto industry to evolve and mitigate the impact of such crises.

The crypto market’s sensitivity to external shocks is not inherently negative. This reflects the maturing nature of the sector and its integration into the global financial system. However, it requires a more sophisticated approach to risk management. Crypto companies must acknowledge the interconnected nature of financial markets and prepare accordingly.

Resilience strategies

One approach to increasing the resilience of the crypto industry is the creation of reserve funds. Setting aside funds during periods of stability can create a buffer to cushion the impact of market declines; this is a similar concept to the tradfi practice of maintaining reserves.

Reserve funds act as a financial safety net by providing liquidity during periods of market stress. Proactive reserve management allows firms to withstand short-term volatility without resorting to panic selling or other reactive measures that could exacerbate market declines.

Another critical measure is the implementation of proof-of-reserve mechanisms to demonstrate a commitment to transparency and accountability. These mechanisms include third-party audits and regular reporting to ensure that companies maintain sufficient reserves to meet their liabilities. This transparency assures investors that their assets are safe and that the company is operating in a financially sound manner.

Looking ahead, it is clear that the relationship between crypto and tradfi markets will deepen. The key lies in our ability to adapt and implement measures that will preserve the long-term stability and resilience of the crypto industry. The integration of institutional capital into the crypto market is both a blessing and a curse. It allows the industry to grow and mature, but it also ties it more tightly to the tradfi markets and makes it vulnerable to the same economic and geopolitical forces.

Gracie Chen

Gracy Chen is the CEO (formerly Managing Director) of Bitget; Gracy oversees the growth and expansion of Bitget’s global markets, strategy, execution, business, and corporate development. She began her journey into the crypto world in 2014 as an investor in the early days of BitKeep (now Bitget Wallet), Asia’s leading decentralized wallet. Gracy was named a Global Shaper by the World Economic Forum in 2015. Additionally, Gracy was selected as a delegate to attend the recently held UN Women CSW68 conference in New York, an event where UN member state representatives and social organizations brought up and discussed critical issues affecting gender equality and women’s rights, addressed issues of poverty and diversity, and strengthened institutions and finance from a gender perspective.