kanchanara ow rGjlqJkM unsplash 3The traditional financial market has been a high critic of crypto in terms of risk. A report shared by the BOG of the United States of America (US) Federal reserve system from a survey by the Federal reserve bank of New York indicated cryptocurrencies do not make it to the top 10 list of potential risks to the US economy.
Cryptocurrencies fell to the 11th spot signalling a change in investor sentiment on blockchain products and decentralized finance (Defi).
In this article, we shall explore the risks as revealed by the report and the part played by digital assets.
Top 11 potential risks to the US economy
These are conditions affecting the stability of the U.S. financial system derived from analyzing vulnerabilities related to valuation pressures, borrowing by businesses and households, financial sector leverage, and funding risks. They also include several near-term risks that, if realized, could interact with these vulnerabilities.
Russia’s invasion of Ukraine – financial conditions abroad has generally tightened since as economies continue to wrestle with the consequences of Russia’s invasion of Ukraine. Escalation of the Russia- Ukraine war would result in higher energy and other commodity prices and the economic outlook in Europe.
- Persistent inflation- Inflation remains unacceptably high in the US resulting in the Federal Reserve tightening monetary policy.
- Risk asset valuations- prices of risky assets falling amid a less favourable outlook on rising interest rates.
- Foreign divestments from US assets.
- High energy prices.
- Corporate credit stress- deteriorating economic outlook amid growing downside risks and heightened uncertainty boiling down widening corporate credit spreads
- Elevated inflation regime.
- Cyberattacks – the risk of loss and disruptions relating to dependence on computer systems and digital technologies, has increased over time. Market analysts suggest that a disruptive cyberattack on the US and its allies could come as retaliation for sanctions imposed on Russia.
- US-China tensions- the risk of US intervention in the military or political conflict between China and Taiwan, would further disrupt global supply chains and weigh heavily on investor sentiment
- Covid-19 variants – although highly relevant the effects of Covid 19 have fallen in prominence since spring.
- Exchange distress -potential credit exposures in case of default by one or more clearing members.
The risk imposed by crypto on the US economy
The report acknowledges the host of ‘useful innovations and products’ that digital assets may provide. The crypto winter, however, showed that the ecosystem faces similar challenges to traditional finance including fraud, opacity, operation risk, runs, and excessive leverage.
The market cap of the largest 100 cryptocurrencies on July 24, 2022, was $1 trillion. That’s a 62% steep fall from a market cap of $2.7 trillion on November 7, 2021.
The report recommends fast action to institute an ‘appropriate environment’ for digital currencies that will preserve financial stability while supporting innovation.
The report also zeros in on TerraUSD, a stablecoin that collapsed from a market cap of $18B in May 2022. The coin had no financial backing and merely relied on investors leveraging high interests from the coin. Concerns about the stability and liquidity of the coin resulted in a death spiral that lasted days resulting in the loss of billions of investor funds.
The collapse resulted in a strain on the entire cryptocurrency market and entities that had direct exposure to the coin found themselves in financial distress or bankruptcy.
The market turmoil did not impact the traditional financial system. The continuous growth of the cryptocurrency ecosystem could however increase connections with traditional finance. Spillover from cryptocurrencies presents the most salient risk to traditional money instruments.
From Zero to Web3 Pro: Your 90-Day Career Launch Plan
