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Collapse of crypto makes investors nervous

Those looking to outsmart inflation might want to avoid this volatile asset class.
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The recent shocks in the cryptocurrency space have generated a lot of headlines, with major ‘digital currencies’ including bitcoin and ethereum seeing their prices tumble following the collapse of the terraUSD (UST) stablecoin and its support coin luna.

The implosion of UST, a token that used an algorithm to maintain its dollar value, has set alarm bells ringing, reports our sister publication, Portfolio Adviser.

Many cryptos have made it to market but not lasted the pace since digital coins first arrived in 2009. But the terra stablecoin was seen as an unexciting token that simply tracked the dollar. In theory, it shouldn’t have been vulnerable.

Its sudden collapse has called into question how the entire crypto market will function in future.

In early April, luna peaked at $116, helped by strong interest from retail investors. But just a month later its value had sunk to zero after its sister token, UST, collapsed in value.

The ‘algorithmic’ stablecoin attracted $80bn of investor money with promises of token-based returns of 20% per annum. When it was clear these returns were not going to happen there was a dash to exit – with those late to the party (as usual) feeling most of the pain.

The wider impact of luna’s collapse was severe – the valuation of exchange Coinbase crashed and the price of bitcoin slumped below $30,000 for the first time since last summer. A far cry from its record high of more than $68,000 which it hit in November 2021.

The collapse in cryptocurrency valuations has also weakened claims that they can provide a hedge against inflation. The luna collapse could well result in more stringent regulation in cryptocurrencies, particularly in regard to stablecoins.

Portfolio kryptonite

A number of big houses have invested in various digital coins – including Blackrock, Fidelity and Ruffer. The latter of which sold out after pocketing $1bn in April 2021. It will be interesting to see how those that are still invested will react following luna’s demise.

Other asset managers such as Baillie Gifford have made inroads into the crypto space by investing in infrastructure players.

Portfolio Adviser reached out to the firms named above, but none wanted to discuss whether the sharp drops in valuations will in anyway change their strategy or thinking on crypto exposure.

Other investment houses have been clear about their skepticism of the unregulated asset class. PGIM, which described it as “portfolio kryptonite”, said the Luna collapse “highlights just one of the many reasons why cryptocurrency is a poor choice for long-term investors”.

Chief executive David Hunt says it meets none of PGIM’s three investment criteria, which include a clear regulatory framework, an effective store of value, and predictable correlation to other asset classes.

Research from PGIM shows that cryptocurrency is also an unreliable portfolio diversifier and an inadequate safe-haven asset or inflation hedge. Recent risk-adjusted returns are not much different than other asset classes but with more frequent and greater drawdowns. Additionally, the unsettled regulatory backdrop and considerable ESG concerns pose significant additional headwinds for long-term investors.

“Cryptocurrency may be a heroic quest to build a viable, decentralized peer-to-peer payment system, but its pricing is based on speculative behavior, rather than a fundamental thesis around its value or utility,” says PGIM’s head of thematic research, Shehriyar Antia. “Furthermore, with little evidence to support it as an effective inflation hedge or safe-haven asset, we see no reason for cryptocurrencies to be a part of institutional portfolios.”

Adopting a wait-and-see approach

Investors’ appetite for the white-knuckle ride that is crypto investing might be severely supressed right now. The “fear of missing out” mindset may no longer have the same pull.

Clara Medalie, research director at cryptocurrency market data provider Kaiko, believes investors are watching how events unfold before they make any move.

“Market sentiment remains bearish following UST’s historic collapse. Investors are taking a wait-and-see approach to see how the aftermath of the collapse plays out and what effect it will have on other stablecoins, particularly with regards to regulation and broader confidence in stabilization mechanisms.”

She adds: “Tether, the largest and most systemically important stablecoin, has not yet fully regained its $1 peg which suggests traders are rotating funds into USD Coin (USDC), which has undergone a strong surge in circulating supply since the de-pegging event”

That said, the crypto world is not exactly unfamiliar to shocks to the system. Last year, bitcoin and the wider crypto market went into meltdown following China’s expulsion of crypto miners and traders – so it has had panic levels before. And some analysts are already talking about signs of a rally now.

Crypto prices have been jumping around following the carnage after luna’s collapse. On Wednesday both bitcoin and ethereum were up on the day – 1.38% and 2.68% respectively, but still down on the week – 4.29% and -13.42%. On Thursday they were in the red again for the day, down 2.17% and 2.27% respectively in late morning trading.

The crypto world may have survived a scary week, but the danger isn’t over and others may yet suffer luna’s fate as liquidity recedes and momentum slows.

Recent bitcoin and crypto price volatility is being blamed to a degree on the Federal Reserve embarking on a tough programme of interest rate hikes in an attempt to drive down runaway inflation.  Given this backdrop, is there reason to expect even more pain for cryptos? Quite possibly, yes.

Less crowded market

Emma Wall, head of investment research & analysis at Hargreaves Lansdown, believes the crypto market will continue to develop but which names will be left standing after a probable shake out is open to debate. She sees little attraction for investors.

“We don’t offer clients access to bitcoin, or any other cryptocurrencies, and have no plans to do so. The FCA has also banned the sale of crypto-derivatives to all retail investors due to the harm they pose. Speculating in cryptocurrencies is extremely high risk and shouldn’t be conflated with investing. Those choosing to speculate on cryptoassets should be only commit money they can afford to lose.”

Wall adds: “We do think that cryptocurrencies will find a place in the financial system in some form, given the interest by large companies and governments. However, it’s very unclear which of the thousands of cryptocurrencies will retain their value in the future and what role they will play in finance.

“Cryptocurrency is still a relatively new phenomenon and market, which means there could be unknown risks.”

Darius McDermott, managing director at Chelsea Financial Services has similar reservations. “We have been of the view that crypto is not a mainstream asset class. Broadly it is so volatile and impossible to value using traditional methods.

He adds: “I am aware that lots of private individuals have made a lot of money but there are plenty that have lost heavily too. They may have diversification qualities but most mainstream funds do not invest in them.”

Part of the Bonhill Group.