The recent cryptocurrency crash has stirred up fears of a larger economic meltdown, and investors are pulling their money out of savings. The lack of liquidity in the crypto markets may have contributed to pessimism and fears of contagion. Pessimism and fear are fueling fears of a hidden crypto crash. Regardless of the cause, there are several possible scenarios. Here are three of them.
Pessimism stokes fears of contagion
The term financial contagion refers to the spread of market disturbances from one country to another. The spread of these market disturbances is primarily measured through co-movements in stock prices, exchange rates, and sovereign spreads. In some cases, financial crisis contagion can extend beyond the boundaries of one country and even across regions. A recent example of financial contagion is the collapse of Long-Term Capital Management, a large U.S. hedge fund. In less than two months, the crisis had spread throughout Southeast Asia, South Korea, and Hong Kong. Economists are increasingly aware of the potential risk of contagion.
The case for anti-contagion measures is compelling. Containment of the financial crisis is in the best interests of all of Europe, but there is no guarantee that such measures will be effective. Pessimism is fueling fears of financial crisis contagion in a way that is not necessarily helpful for the economy. However, it’s worth taking some precautionary measures now.
Investors may have been taking money out of their savings
The recent cryptocurrency crash has raised fears of a similar financial crisis to that of 2007 as it has wiped out nearly $2 trillion in value. But while the stock market has been falling for some time, the collapse in crypto prices may be even worse, due to the lack of liquidity in the markets. Investors may have been withdrawing their savings to purchase cryptocurrencies, which had a similar effect.
A crypto crash may have been the catalyst for some investors’ panic. Some have compared the crash to a bank run. However, cryptos have not yet reached mainstream investors like tech stocks and have not yet become a reliable investment. So, it may be a good time to take a slow approach and start investing slowly. Moreover, the industry has experienced de-risking already, but the crash is a warning to keep an eye on the situation.
Stablecoins may have imploded
As the value of stablecoins plummeted and some investors sought alternative assets, some have speculated that an algorithmic model is responsible. This idea is based on a new type of digital currency, called algorithmic stablecoins. They are backed by volatile assets and are susceptible to herd behavior. The price of one algorithmic stablecoin, the IRON, plunged to 54 cents during European trading hours, precipitating calls for regulation by investors including Mark Cuban.
The collapse of TerraUSD in early May has drawn scrutiny to the stability of the stablecoin sector. The company has faced severe problems with its technology, and the collapse of TerraUSD has sparked fears of a crypto bank run. However, Tether’s collapse may have been an isolated case. Other stablecoins are still in operation. The recent Tether collapse shows that unregulated private stablecoins have similar risks to bank runs.