According to new research, the COVID-19 pandemic has sprung up unexpected and revealing patterns among cryptocurrency traders. Hadar Y. Jabotinsky And Roee Sarel observed in their paper entitled “How Crisis affects Crypto: Coronavirus as a Test Case,” posted to the Oxford University Law Faculty blog, that the crypto markets were taking a pronounced U-turn midway through the crisis.
Analyzing the period January 1–March 11, the researchers found that initially both the spot market prices and the overall volume of trading increased as the number of COVID-19 cases identified increased. This positive correlation then reversed, and investors began to pull their cash out of the crypto and declining markets began.
The researchers argue that the initially positive correlation between the spreading virus and an increase in market cap and crypto volume 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, this trend started to reverse around Feb. 28, with investors appearing to react even more strongly to the number of deaths than to new infections.
They note that around the time that total cases hit 50,000, the number of newly-identified infections started to slow down. This may indicate that traders interpreted an apparent lull in disease spread as a positive sign for financial markets, prompting them to move back to traditional assets.
Notably, this negative momentum in the crypto sector did not reverse back then, even as the number of new cases began to exponentially increase again in early March.
Conclusions for Regulators
The paper draws several key conclusions from these findings, noting that cryptocurrency markets could be understood in one view as a source of systemic risk to the traditional financial system in times of crisis, especially given that the new sector has become increasingly interconnected with legacy financial institutions.
While a mass exit from the traditional markets to crypto may aggravate the instability of the system, the researchers note that the lessons to be learned are that regulation must be targeted and, crucially, time-sensitive. An intervention that comes too early or too late will be counter-productive, because crypto markets do not seem to respond linearly to the crisis:
“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.”
Crypto can potentially offer investors a viable lifeline at key junctures during times of macroeconomic stress — one that should not be stifled by unjustified 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, during the pandemic, a crypto-based app that helps users create an emergency microeconomy has reported an enormous increase in monthly downloads.