Crypto and financial stability

July 14, 2022

A lot of turmoil in crypto. Does that mean crypto markets should be regulated? The turmoil is driven by violent price volatility, exposing weaknesses in technology and business models. Any financial stability impact arises from that. Fundamental to crypto volatility is the nature of demand and supply. A lot of investors sell, so the price drops. Why do they sell?

The price of crypto is partly driven by the true believers who have bought into the political mission — mistrust of societies' institutions. While they are critical for public relations, the vast majority of crypto investors are just momentum traders who buy when prices go up and sell when they drop. That means we can analyse crypto volatility using the same methods we use for other highly speculative assets — like tulips in 1600, commodities in 1763, stocks in 1929, Yahoo in the late 1990s and tech stocks today.

Turmoil by itself does not translate to financial instability. In crypto's case, its connection to the real economy is minimal, as is its connection to the traditional financial system.

Unless that changes, there is little reason to worry about crypto from a financial instability point of view.

However, even if there is a problem that merits regulations — my last statement is wrong — that does not mean regulations will solve the problem. Will the regulators know what to do? Or are they like their monetary policy colleagues?

Would it be yet more Illusion of Control?

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