The COVID-19 pandemic has sparked unexpected and revealing patterns among cryptocurrency traders, according to new research.
In their paper entitled “How Crisis affects Crypto: Coronavirus as a Test Case,” posted to the Oxford University Faculty of Law blog on April 17, Hadar Y. Jabotinsky And Roee Sarel observed that the crypto markets took a pronounced U-turn midway through the crisis.
Analyzing the period of Jan. 1–March 11, the researchers found that initially, both spot market prices and overall trading volume increased as the number of identified COVID-19 cases rose. This positive correlation then reversed and investors began pulling their cash out of crypto and the markets began to decline.
What accounts for this u-turn and what, if anything, can regulators learn from it?
The researchers argue that the initially positive correlation between the spreading virus and a rise in market cap and volume in crypto implies that, at first, traders viewed crypto as a reliable source of liquidity and an effective safe-haven asset.
Yet after the number of global cases hit 50,000, around Feb. 28, this trend began to reverse, with investors appearing to respond even more strongly to the number of deaths than to new infections.
Around the time that total cases hit 50,000, they note, the number of newly-identified infections began to slow down. This potentially indicates that traders interpreted an apparent lull in the spread of the disease as a positive sign for the financial markets, prompting them to move back toward traditional assets.
This negative momentum in the crypto sector notably did not then reverse back, even as the number of new cases began again to increase exponentially in early March.
The paper draws several key conclusions from these findings, noting that the cryptocurrency markets could, in one view, be understood as a source of systemic risk for the traditional financial system during times of crisis — particularly given that the new sector has become increasingly interconnected with legacy financial institutions.
While a mass exit from the traditional markets into crypto can aggravate the system’s instability, the researchers note the lessons to be learned are that regulation needs to be targeted, and crucially, time-sensitive. An intervention that comes too early or too late will be counterproductive, as crypto markets do not appear to respond to the crisis in a linear way:
“Insofar that the initial uptake in cryptomarket occurs due to pure externalities – so that market players do not internalize the risk – regulation would be welcome. On the flipside, any regulation must be careful not to undermine the benefits which make the cryptomarket potentially more reliable at a time of crisis.”
During times of macroeconomic stress, crypto can potentially offer investors a viable lifeline at key junctures — one that should not be stifled by ill-judged intrusion:
“In particular, if traditional markets crash, firms can raise funds by issuing security tokens – which would ease liquidity constraints and reduce the risk of a bank run.”
As reported earlier this week, a crypto-based app that helps users to create a micro-economy in times of emergency has reported a huge surge in monthly downloads during the pandemic.