What could trigger cryptos’ worst nightmare & what may it look like?

Highlights 

• There are convincing reasons to believe cryptocurrencies are the future, but also to believe they are a bubble.
• If central banks come together to rein in the space, the house of cards may collapse in seconds
• It’s possible that more than institutional backers of cryptocurrencies, the burst of the crypto bubble will hurt retail investors.

Believe it or not, we are in the midst of one of the biggest disruptions of the 21^st century. And, believe it or not, one of the most powerful global currencies of today, the United States dollar, has been in existence for just over two centuries -- the 18^th century Industrial Revolution began before the US dollar. The point is the current version of government-issued money is not as ancient as it might sound.

 Source: Pixabay

The Coinage Act of 1792 was the turning point as it introduced the US dollar, which was to be pegged to the Spanish dollar. And it wasn’t until the First World War that the US dollar gained a hegemonic spot in the reserve currency space.

Why can’t decentralized digital currencies replace government-issued fiat currencies? We are indeed in a modern world where shopping is shifting from physical marketplaces to e-commerce, mobility is shifting from fossil fuels to lithium batteries and hydrogen, and the founders of these new-age tech companies are toppling others to cement their positions in the list of the richest people on earth.

Also read: Can Bitcoin end 2021 with a price tag of $100,000?

If we could move from agriculture to manufacturing, from manufacturing to services, and from services to tech-enabled services, why is a move from a physical, centrally controlled fiat currency regime to digital, decentralized currency being considered improbable? But wait -- not every tech advancement is viable, and adoption of cryptocurrencies as a medium of exchange or as a tradable asset is fraught with uncertainties.

What could trigger Crypto World's Worst Nightmare?

Let’s find out what can trigger a crash in the glittery world of cryptocurrencies.

The ire of central banks and governments

In the first physically held G20 meeting since the outbreak of the pandemic, if there was one thing that the world leaders could unequivocally commit to, it was the pledge to not prematurely withdraw stimulus to the ailing economies.

From the US to the UK to Canada, central banks have maintained near-zero policy rates to infuse liquidity in the market. Borrowing costs have tumbled and individuals are taking out mortgage loans. Such policy measures are only possible when currency is controlled by any central authority.

The Fed can use various measures like quantitative easing to manage liquidity. Now that prices of almost everything, from food to fuel to clothing to houses, are skyrocketing, central banks are contemplating at least some cuts to the liquidity push.

Also read: How are low interest rates helping Canada & US?

Bitcoin as a medium of exchange and a form of money can leave central banks with no teeth. The biggest unique selling proposition (USP) of cryptocurrencies is that there is no central authority and a distributed network is at the heart of the arrangement.

Arguably, it would take a few minutes for the Fed to bring down cryptocurrencies no matter their multi-trillion dollar market cap. As of now, regulators are stopping short of the term ‘ban’, although China did not hesitate. For now, it’s all about ‘regulating’ the cryptocurrency space, that’s it. This grey stance has left enough room for speculators to sell dreamy propositions about cryptocurrencies. But, until when?

The whales booking profit

Did you know that nearly 70 per cent of the total circulation of the Shiba Inu cryptocurrency is controlled by just eight accounts?

 MicroStrategy

Over the past week, this cryptocurrency has gained multifold and was one of the top trending crypto assets. Of the 70 per cent owned by ‘whales’, one owns nearly 40 per cent. That’s a real concentration of power even when the space boasts of no controlling authority.

Shiba Inu is one of many meme coins (cryptocurrencies that started as memes), one of which, Dogecoin, has Elon Musk’s attention. Nobody precisely knows who these whales actually are. And whales exist in all cryptocurrencies. For now, whales are finding takers for the tokens they hold, but what if these new buyers fail to find the next league of believers?

Whales booking profit is very different from central banks’ negative stance toward cryptos.

We have to understand that the former relates to a situation where cryptocurrencies are tradable assets. In the latter, they are a rival to the supremacy of fiat currencies. The present-day narrative is that Bitcoin may be a better hedge than gold against inflation. Here, cryptos are being considered as an asset that can return multifold profits in a short period to provide cushioning against high prices.

Also read: Is Bitcoin better than gold as hedge against high inflation?

What will the crypto nightmare be like?

The nightmare might bring evaporation of all value in the blink of an eye. As of now, the total market cap of all crypto assets is nearly US$2.5 trillion. Bitcoin’s share is almost 44 per cent, and that of Ether’s is nearly 20 per cent.

Also read: Can Bitcoin be termed as the ‘asset of the century’?

Arguably, the entire cryptocurrency world rests on one key pillar -- Bitcoin. Any collapse in Bitcoin could trigger a burst of the entire bubble, if cryptos are one.

According to Coinbase, a NASDAQ-listed crypto exchange, retail investors have a share of nearly 35-40 per cent in the overall trading volume. Institutional investors make up the rest. The share of retail investors denotes billions of dollars parked by individuals in the volatile world of cryptocurrencies.

Institutional investors often have cushioning to avert any major disaster from a particular investment. Retail investors, who are increasingly subscribing to the HODL (hold on for dear life) theory, are much more vulnerable.

The eye-popping gains in some cryptos like Shiba Inu and blockchain-based game Axis Infinity might have made some amateur retail investors think that cryptos are the best bet. A burst of the crypto bubble could be a catastrophe for these investors.

Bottom line

One may consider cryptocurrencies as the upcoming new-age money and medium of exchange or an asset that can be traded like listed shares. But in both scenarios, headwinds could inhibit the progress.

Even if the regulators continue their restrained approach toward cryptocurrencies, it could be the lack of further enthusiasts that may bring the downfall triggered by demand and supply gaps. This collapse would upset retail investors more than it impacts seasoned institutional investors.