The Banking Executive Magazine - May 2022 Issue

Cryptocurrencies and Blockchain Technology MACRO RISKS FROM THE CRYPTOCURRENCY BUBBLE Could volatility in Cryptocurrencies cause risks to global financial stabil- ity, like in the .com and housing bub- bles? When Bitcoin fell by more than 40% in May 2021, the volatility cer- tainly provoked fears of instability. At this point, this comparison likely overstates the risks to the broad economy. Let us check if there are similarities between the cryptocur- rency surge and the internet bubble in 2000: • Blockchain technology has gener- ated considerable excitement de- spite confusion about how it works or could be used. • Price swings in Cryptocurrencies appear to be driven by momentum rather than by changes in funda- mentals. • Valuations are very difficult to jus- tify using traditional cash flow dis- counting models and seem to be based instead on new and untested paradigms. Part of the damage caused by the bursting of the housing and tech bub- bles came from very broad wealth losses, reflecting the diffusion of tech stocks and toxic credit instruments across households, corporate portfo- lios and bank balance sheets, as well as significant leverage. By contrast, the effect of the May 2021 Bitcoin collapse was pretty mild, showing that the diffusion of these instruments is not yet large enough to create spillover effects. ARE CRYPTOCURRENCIES IN MANY PORTFOLIOS? Tracking the distribution of Cryp- tocurrencies in retail and institutional portfolios is complicated. According to Bloomberg, 2% of accounts con- trol 95% of all bitcoins. But these measures could be misleading be- cause they are based on virtual ad- dresses that can hide multiple users. Another recent report estimates that 31% of bitcoins are held by very large non exchange entities like insti- tutions, funds, custodians, over-the- counter desks and some high net worth individuals. On the other hand, it found that smaller entities represent around 23% of owners, in- dicating significant retail interest that has increased since 2017. Institu- tional investors are gradually grow- ing but still have a low presence in this market, reducing the risk to fi- nancial stability from Cryptocurren- cies for the time being. THE ROLE OF CRYPTOCURREN- CIES IN PORTFOLIO Three beneficial roles Cryptocurren- cies might play within a portfolio: as the BANKING EXECUTIVE 38 ISSUE 161 MAY 2022