Crypto Winter Will Be Different This Time
Winter is coming, not just in the seasons but in the crypto market. If the current downturn turns into another crypto winter, it will have a bigger impact on the mainstream financial system than it has in the past.
Bitcoin has fallen 30% in less than two months and is down for the year, while other cryptocurrencies have crashed by much more. This has occurred despite the most crypto-friendly regulatory environment ever. What’s become clear is that instead of building an alternate financial system, the crypto industry used its newfound freedom to go crazy.
As my colleague Yueqi Yang has written, that meant memecoins on the stock market, nearly infinite leverage on some exchanges, and crypto-driven prediction markets that made betting on the end of the government shutdown a daily pastime. You may not have noticed amid the carnage, but this week an exchange-traded fund that tracks dogecoin debuted on the New York Stock Exchange (it’s actually up by a few pennies).
Some of this is just crypto being crypto. The thing to watch this year, and maybe the riskiest development in crypto, has been the rise of stablecoins. These cryptocurrencies, which are pegged to the dollar, are the closest thing to an alternate financial system. The most boring part of crypto got blessed with a friendly new law dubbed the Genius Act, giving it instant credibility.
That’s led to a bunch of new stablecoin announcements and increased use, especially overseas. This week Klarna, the Swedish buy-now-pay-later provider, said it would launch a stablecoin called KlarnaUSD next year. They are joining payments company Western Union and cloud company Cloudflare in creating new offerings. Stablecoins are currently dominated by Circle and Tether, which together have a market cap of roughly $250 billion.
Before we delve further into stablecoins, though, it’s worth looking more into the current meltdown. Ground zero for the sell-off is a Singapore-based crypto exchange, Hyperliquid, that handles $13 billion in trades a day with 11 employees and offers staggering amounts of leverage. It was home to a $10 billion liquidation in October that ricocheted across markets. Hyperliquid also has a stablecoin.
On the traditional stock exchanges, crypto treasury stocks—listed companies stuffed with crypto—are among the biggest losers. Until recently, the euphoria in crypto meant these stocks traded at a premium to their crypto holdings. Investors decided that paying $2 for every $1 of crypto was a good idea. The companies logically issued stock or borrowed money to buy more crypto, driving up prices.
This trade has unwound painfully, and now the crypto treasury companies are trading at a discount to their holdings. The logical move for them is to sell crypto and buy back their shares. That cycle of selling can drive down prices.
All that is a reminder that stablecoins’ promise of zero volatility warrants some skepticism.
Because they are more closely linked to the financial system than any other form of crypto, stablecoins require more scrutiny and caution. They are also closer to real money than anything else in crypto because they meet one crucial criteria of money–they are a store of value. Dogecoin can’t say that.
Stablecoins keep their 1:1 peg against the dollar by holding safe assets such as short-term Treasurys, bank deposits and money market funds. That’s legit, and is required by the stablecoin law. It is ironic that stablecoins rely on traditional financial tools, which much of crypto disdains, to maintain their stability.
History has shown it’s easier to promise stability than to deliver it. Just this month, a small, fringe stablecoin blew up, wiping out around $200 million. The stablecoin, run by a company called Stream Finance, promised a yield of around 18% but collapsed after losing $93 million.
Stream Finance realized quickly that the promise of stability has a dark side—the bank run. While the company’s stablecoin operates differently than the major ones, the investor reaction is the same. It’s one thing to lose money on a risky investment. It’s another to lose your savings. That invites panic, frantic withdrawals and crashes, and these have happened in every asset that promises to give people their money back in full.
“There has been a run, there will be a run, money market funds, repos, you name it, there will be a run,” said Lee Reiners, a fellow at the Duke Financial Economics Center and a former Federal Reserve official.
But memories are short, especially in crypto. When Silicon Valley Bank failed in 2023, one of the biggest casualties was Circle, the dominant stablecoin in the U.S. When Circle announced it had $3.3 billion of assets in SVB, it suffered its own bank run, and its stablecoin fell to 88 cents on the dollar. It was saved when regulators said the federal government would make all deposits at SVB whole.
Reiners points out that SVB failed because its supersafe Treasury holdings lost value when interest rates rose. “This is the nature of those things—you don’t know how the contagion will play out,” he said.
The Genius Act, which has yet to take effect, makes it seem that stablecoins have official backing, and that has spurred more use of them, especially overseas in countries where people want access to dollars because of unstable currencies or capital controls. Stablecoins are the easiest way to obtain and move dollars in places like Argentina and Turkey, but that makes stability even more critical.
Their broader use also creates more ways for a stablecoin crisis to emerge and spread across the globe. It is here that the links to the traditional financial system matter. If investors dump their stablecoins, as they did with Circle, the companies sell the assets that back them, potentially causing turmoil in Treasurys, money markets and the like.
As I said, memories are short. A crack in a money market fund led to one of the darkest moments of the 2008 global financial crisis. Drama in the Treasury market has caused several crises.
Stablecoins add another source of unpredictable risk to the financial system. In retrospect, everyone will say we should have seen it coming.
New From Our Reporters
