25 May 2021 3 min read
Could a crash in cryptocurrencies become a systemic risk?



Cryptocurrencies have taken a beating recently. Last week, Elon Musk complained about the carbon impact of Bitcoin and reversed his pledge to allow purchases of his company’s cars with the largest cryptocurrency (Bitcoins represent 65% of the total crypto market cap). On top of that, the People’s Bank of China added to the pain by reiterating that digital tokens can’t be used for payments. Both risks have been highlighted in a previous blog.

But even after this latest drawdown, the crypto market is still worth a sizeable $1.7 trillion, equivalent to about 15% of the gold market or the market cap of Microsoft*. So, given its reasonable size, the question arises of whether a crash in cryptocurrencies could become systemic. We think that is unlikely. Systemic risk depends on who holds the asset and whether these holders are leveraged players, which could trigger forced selling and an escalation of downward momentum that affects other assets as well.

Ownership data on cryptocurrencies are a bit murky. This shouldn’t be a surprise to anyone, as one attraction of using them is that you can hold and exchange them anonymously. Therefore, it’s no stretch to believe that these ‘currencies’ are used by money launderers, tax avoiders, and evaders of trade sanctions and capital controls.

Just recently the US Treasury announced that it wants cryptocurrency transfers to be reported like cash transfers. I’m not sure this will discourage the money launderers and tax evaders, but it may be just the beginning of a crackdown.

As an aside, it also sadly reflects the huge size of the ‘black economy’ and lack of trust in governments. This all coincides with savings being high and even the mainstream media proliferating stories of how to make a fast buck (which could equally be applied to SPACs), while ‘free’ technology platforms offer access to quick and seemingly costless or low-cost transactions.

At the margin

More broadly, Bloomberg reports that crypto ownership is very concentrated. There are 200 million cryptocurrency users worldwide, but 2% of the accounts own 95% of the digital assets and more than 70% of Bitcoin addresses have less than 0.01 Bitcoin each. Institutional investor ownership is still quite low too, with JPMorgan* estimating the market cap of Bitcoin funds at only about $10 billion; a mere fraction of mutual funds and institutional investors invest in cryptos at all.

Finally, it is difficult for an institutional investor to create leverage in these ‘currencies’. Given the enormous volatility of these contracts, margin requirements are simply too high. For instance, Bitcoin futures have close to a 100% margin requirement, so there is essentially no opportunity to leverage. In fact, there is an interesting article from the FCA here suggesting that young retail investors are likely to be among the worst affected.

So we conclude that though a crypto sell-off may cause pain to some players and may lead some leveraged players to default, especially trading platforms that don’t adjust margins intraday, we think it is quite unlikely that this would become a systemic risk.


*For illustrative purposes only. Reference to a particular security is on a historical basis and does not mean that the security is currently held or will be held within an LGIM portfolio. The above information does not constitute a recommendation to buy or sell any security.

Emiel van den Heiligenberg

Head of Asset Allocation

Emiel is responsible for the overall strategic direction of the team’s investment and business strategy. He claims to have been a promising lightweight rower at university until French fries got the better of him. Reflecting his love for rowing in a team, he firmly believes that excellence can only be achieved by a great team made up of motivated individuals that are also eager to work together. To this end he is the self-proclaimed inventor of the verb 'teaming' to acknowledge that shaping a top team and culture of excellence is an ongoing process. Outside of work-family obligations, Emiel’s spare time is filled by a passion for shark diving and skiing. Prior to dedicating his career to portfolio management in 1996, Emiel worked as a policy adviser in the Dutch Ministry of Finance and he graduated from Tilburg University in the Netherlands ages ago. When not glued to his Bloomberg screens, this Dutch man is hooked on computer games, peanut butter and his favourite dark beer made by Belgian monks.

Emiel van den Heiligenberg