How Would Another Financial Crisis Affect the Crypto Markets?

Bitcoin and the blockchain protocol developed in the midst of a massive global financial crisis that is still affecting people ten years on. It is a common thought experiment to theorize on how well the cryptocurrency revolution would stand up to another financial crisis, not just among the crypto community, but in financial institutions across the globe.

Recent developments in global economics make this more than a theoretical postulation, it’s trying to see what the future will hold and how to avoid the worst effects of the next financial crash. The potential economic risks that come from the U.S. trade war with China, instability in Italian debt markets, and Deutsche Bank job cuts are building up into a cumulative effect that could topple the world once again into monetary crisis.

Cryptocurrency - Kill or Cure?

There are opposing theories on what will happen to the cryptocurrency markets in the face of another global market crash. On one side there are the bulls, the Bitcoin holders and traders that think that the next economic crash will be the baptism of fire for cryptocurrencies. On the other, side there are the bears, the pessimists (they may even be crypto-holders themselves) who believe that financial crisis will cause the devastation of the crypto world.

It possible that both could happen in varying degrees, depending on when the crash happens and how far Bitcoin (and other fiat-replacing coins) has been adopted into mainstream usage.

Bearish crypto-detractors

The bears have it that a crash in the global economy will bring about a crash in cryptocurrency markets. Anyone holding crypto will automatically try to cash-out of the market in an attempt to liquidate their holdings into usable cash currency. Effectively crashing the crypto markets down to nothing in the rush to sell crypto-holdings at the highest possible price.

Bullish pro-crypto

The bulls believe that after the first sell-off and the initial effects of the crash begin to settle there will be a sudden wave of people ‘buying the dip’ and crypto will regain value. This renewed upsurge in the market would bring with it the new-found stability that the ‘money’ you have in your cold wallet isn’t controlled by any government or bank who could take it away or freeze your accounts.

Positive and Negative Correlations.

There are robust theories and analyses to back both the bulls’ and the bears’ arguments. The optimistic bulls have the opinion on their side that Bitcoin has a -0.14 correlation with other financial instruments (-1 is a 100% negative correlation and +1 is a 100% positive correlation) which is basically neutral, but it is slightly negative, indicating that Bitcoin at least wouldn’t follow the rest of the financial world in crashing through the floor.

On the other side of the argument, the bulls’ perspective is that in a financial crisis “all correlations go to +1”, indicating that, irrespective of current correlations, when the markets crash everything crashes, we have to wait and see where everything lands.

So Who is right?

While the bullish sentiment acknowledges that an initial sell-off will happen before the market recovers, the bearish feelings don’t believe that the market will recover. And they could both be correct; it just depends when it happens and how far along the crypto development path we are.

The genesis of Bitcoin and the blockchain happened in the midst of the last crisis, but it was subversive and only of particular interest to the tech-savvy. Now, that has changed, and most of the world knows about Bitcoin, and its offshoots. However, whether cryptocurrency attains any level of mainstream adoption is debatable.

Public perception of cryptocurrency will be the crucial factor

Right now “Joe Public” gets paid in dollars or euros (or any other fiat currency according to his location), he can pay his bills with it, his local grocery store accepts it, and he can save a bit under his mattress just in case things get bad. He’s not going to change that methodology unless circumstances force him into it.

So far in the cryptocurrency development cycle, we have a certain degree of adoption. Digital assets and some physical commodities can be bought with BTC, a few letting agents even allow for paying your rent with it, but it is far from the general utility that would allow for universal switching from fiat cash to a digital coin in times of hardship. You can’t pay your taxes with it, and in most cases, you can’t buy your groceries with it.

If the next financial disaster were to happen ‘tomorrow’, then I believe the bears would have the right idea. Without utility, there is no hope for widespread adoption of cryptocurrency as an alternative to inflationary fiat currency. If the downturn were to hit without that utility, the costs of implementing retail cryptocurrency acceptance would be too much for an economy already in dire straits.

Alternatively, if the next economic downfall should happen somewhat further in the future (say 2-3 years), then I think the bulls will have won.  Cryptocurrency will have survived the ups and downs to become a more stable investment option; institutional investment will make the markets less volatile; more retail companies will accept digital coin payments, and Walmart will let you buy bread and coffee with Satoshi, etc.

For all the hype and commercial and institutional interest in the digital currencies, it is the perception of the lay people in the street that will turn the tide of acceptance from niche markets to universal usage. The broad spectrum of society will need to embrace digitization

Summary

The next economic crash will come and the performance of cryptocurrencies in that period will depend heavily on when the downturn happens and how close cryptocurrency is to universal (or at least widespread) utilization.  

While Bitcoin and its siblings have shown resistance to economic factors that usually affect financial markets, they are not wholly immune to the effects of a market collapse. Whether crypto moves in direct correlation with the rest of the financial world or direct opposition is yet to be seen. However, it would be naive even to consider that currency, so far untested in the choppy waters of a market crash, could maintain complete isolation from all of the other financial instruments and continue on its way.

The best advice that I think fits almost all situations is “Hope for the best, plan for the worst.” and it works for this too. Don’t bet all of your savings on crypto, but don’t assume that fiat cash is the only way either.

The longer it takes for us to feel the first stirrings of economic instability the longer cryptocurrency has to inveigle itself into the financial make-up of the global economy, thus gaining acceptance, legitimacy and utility. That is what will be needed for the general public to make cryptocurrency a viable alternative to inflationary fiat.

Another financial crisis will be the proving ground for cryptocurrency as a whole. Some coins may thrive while others disappear. It will be the baptism of fire that proves whether the blockchain-based digital money is the future of global finance.

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