Why the $2 trillion crypto market crash won’t kill the economy

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Carnage in the crypto market won’t let up, as token prices plummet, companies lay off employees in waves, and some of the most popular names in the industry go belly up. The chaos has spooked investors, erasing more than $2 trillion in value in a matter of months — and wiping out the life savings of retail traders who bet big on crypto projects billed as safe investments.

The sudden drop in wealth has stoked fears that the crypto crash might help trigger a broader recession.

The crypto market’s sub $1 trillion market cap (which is less than half that of Apple’s) is tiny compared to the country’s $21 trillion GDP or $43 trillion housing market. But U.S. households own one-third of the global crypto market, according to estimates from Goldman Sachs, and a Pew Research Center survey also found that 16% of U.S. adults said they had invested in, traded, or used a cryptocurrency. So there is some degree of national exposure to the deep-sell off in the crypto market.

Then there’s the whole mystique around the nascent crypto sector. It may be among the smaller asset classes, but the buzzy industry commands a lot of attention in popular culture, with ads on major sporting championships and stadium sponsorships.

That said, economists and bankers tell CNBC they aren’t worried about a knock-on effect from crypto to the broader U.S. economy for one big reason: Crypto is not tied to debt.

“People don’t really use crypto as collateral for real-world debts. Without that, this is just a lot of paper losses. So this is low on the list of issues for the economy,” said Joshua Gans, an economist at the University of Toronto.

Gans says that’s a big part of why the crypto market is still more of a “side show” for the economy.

No debt, no problem

The relationship between cryptocurrencies and debt is key.

For most traditional asset classes, their value is expected to stay moderately stable over some period of time. That is why those owned assets can then be used as collateral to borrow money.

“What you haven’t seen with crypto assets, simply because of their volatility, is that same process by which you’re able to use it to buy other real world assets or more traditional financial assets and borrow off that basis,” explained Gans.

“People have used cryptocurrency to borrow for other cryptocurrency, but that’s sort of contained in the crypto world.”

There are exceptions — MicroStrategy took out a $205 million bitcoin-backed loan in March with the crypto-focused bank Silvergate — but for the most part, crypto-backed loans exist within an industry-specific echo chamber.

According to a recent research note from Morgan Stanley, crypto lenders have mostly been loaning to crypto investors and companies. The spillover risks from tanking crypto prices to the broader fiat U.S. dollar banking system, therefore, “may be limited.”

For all the enthusiasm for bitcoin and other cryptocurrencies, venture capitalist and celebrity investor Kevin O’Leary points out that most digital asset holdings are not institutional.

Gans agrees, telling CNBC that he doubts banks are all that exposed to the crypto sell-off.

“There’s certainly been banks and other financial institutions, which have expressed interest in crypto as an asset and as an asset that they might like their customers to also be able to invest in, but in reality, there isn’t that much of that investment going on,” explained Gans, noting that banks have their own set of regulations and their own need to make sure that things are appropriate investments.

“I don’t think we’ve seen the sort of exposure to that that we’ve seen in other financial crises,” he said.

Limited exposure

If bitcoin went down another 20%, it wouldn’t really matter because it’s spread around everywhere

Kevin O’Leary

Venture Capitalist

Some analysts on Wall Street even believe the fallout of failed crypto projects are a good thing for the sector overall — a sort of stress test to wash out the obvious business model flaws.

“The collapse of weaker business models such as TerraUSD and Luna is likely healthy for the long term health of this sector,” said Alkesh Shah, global crypto and digital asset strategist at Bank of America.

Shah says the weakness in the crypto and digital assets sector is part of the broader risk asset correction. Rather than driving the economy down, crypto prices are tracking tech equities lower, as both succumb to pressure from greater macroeconomic forces, including spiraling inflation and a seemingly endless succession of Fed rate hikes.

“Higher than expected rate hikes coupled with recession risk has broadly hit risk assets including software and crypto/digital assets. With central banks globally tightening, my strategy colleagues expect central banks to take about $3 trillion of liquidity from markets globally,” continued Shah.

Mati Greenspan, the CEO of crypto research and investment firm Quantum Economics, blames the Fed’s tightening as well.

“Central banks were very quick to print gobs of money when it wasn’t needed, which led to excessive risk taking and reckless build up of leverage in the system. Now that they’re withdrawing the liquidity, the entire world is feeling the pinch.”

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