What the crypto collapse means for mainstream portfolios

What the crypto collapse means for mainstream portfolios

The impact of the collapse of the crypto currency market on wider client portfolios “is only just beginning to be felt”, according to David Jane, multi-asset investor at Premier Miton.

He said: “It is easy to think of the whole Bitcoin/crypto sphere as an amusing sideshow to financial markets. However, the impact of its ongoing collapse may be more widespread than it first seems.

"The most obvious effect is a wealth effect on other markets and consumer spending. It is known that a lot of the stimulus sent out by governments during the lockdowns found its way into crypto. In many cases, this money was leveraged into other assets. The paper gains would have led to additional consumption. This is now reversing. There is certainly potential for a negative wealth effect and its scale could be material.

"The consequences of the crypto crash might be much more widespread than the simple wealth effect. Most crypto now is held on crypto exchanges. These exchanges offer leverage, like stockbroker accounts. A customer deposits money but is able, for a fee, to borrow to buy materially more assets.

"At the same time, customers are able to deposit their crypto assets for an interest payment. This is a form of time deposit or perhaps a stock lending scheme. Interest rates on these deposits can be very high. These exchanges are, to all intents and purposes, banks. They take deposits, offer lending and so on. The big problem here is that they are very opaque and more entangled with the mainstream financial system than seems apparent.”

The wealth effect to which he refers is the notion that as crypto investors note the losses they have made on those assets, they feel poorer, and rein in spending and investment in other areas, thereby impacting the performance of mainstream financial assets.

But Jane said the impact could be broader than that. He added: “Total losses in crypto since the 2021 peak are estimated at over $2tn, which is certainly a material sum and around 8 per cent of US GDP ($23tn as at December 2021). Arguably, we are only at the beginning of the unravelling process and the knock-on effects onto mainstream financial markets might only just be beginning to be felt. We remain very cautious at present and are running defensive portfolios, at least until we are able to scale the impacts of this and other consequences of monetary tightening on the economy and financial markets.”