Cryptocurrency Valuation Swings and Centralization
Cryptocurrency Valuation Swings and Centralization

Lately there has been some skepticism regarding the stability of cryptocurrencies. This may be in part due to the spectacular Q3/Q4 crypto had in 2022 after a meteoric rise earlier that year. With the disclaimer that I am an engineer and attorney by training, not an analyst, I’d like to address some of this skepticism. This is not financial advice.

Technological Security        

First, these dramatic increases and falls in value have little to do with the technology itself. For example, the Bitcoin chain has not had any security incidents and has experienced only two major outages[1] as of this writing. Compared to other well-known services such as AWS and Facebook, a 99.99% uptime is an incredible feat. While these outages were caused by bugs, the issues were resolved in less than 10 hours with no financial damage beyond the loss of trading hours. More notably, the Ethereum chain has never experienced an outage aside from a Distributed Denial of Service (DDOS) attack in 2016.[2]

Instability Caused by Centralization

The stability of the technology implies the value of these coins should also be stable with no wild fluctuations. So, what’s happening? While originally intended to be an isolated currency free from the influences of traditional markets, this is not the case. Numerous factors, such as the complexity of maintaining a fully decentralized wallet and the inherent tie to fiat currencies for trading, link crypto currencies to traditional markets. Third parties such, such as Coinbase, facilitate wallet management and act as a broker. Storing wallets with third parties centralizes what is supposed to be a decentralized currency, acting as a bank of sorts. Coinbase for instance, also stores client cash in conventional bank accounts, further centralizing the currency.

Market Forces and Silicon Valley Bank

This originally unintended centralization ties cryptocurrencies to traditional market forces. Take the Silicon Valley Bank (SVB) failure for example; there is a clear correlation between the events of the collapse and the prices of Bitcoin and Ether.

1: Google Finance as of 3/20/23[3]

On Friday March 10, 2023, SVB was shut down by regulators, correlating to a dip in Bitcoin and Ether value on that date. Crypto began to recover on Sunday, March 12 when it was announced that customers would have access to their deposits on Monday, March 13 within 24 hours. Crypto saw a full recovery. Crypto values went up further on Tuesday, March 14 when it was announced there would be bailouts for SVB. Why the correlation between a supposedly decentralized currency and a traditional bank? SVB offered numerous crypto related services such as custody services and lending. These services directly tied cryptocurrency to a traditional bank, partially centralizing it.

In addition to crypto’s direct ties to SVB, a number of crypto-related companies had exposure to the bank, such as Ripple, BlockFi, Avalanche, Pantera, Nova Labs, and Circle. Circle in particular was problematic as they maintained $3.3 billion cash backing their stablecoin, USDC, with SVB. These exposures created fear in the crypto market, prompting a run on crypto along with the run on the bank, driving the value down.

Crypto’s Rebound

Crypto bounced back fast. As faith in conventional banking systems waned, people began buying more crypto. The values of Ether and Bitcoin are up 8% and 15% respectively[4] from a month ago (before SVB’s failure), as of this writing. Crypto-related app downloads are up 15%[5] since SVB’s collapse, as of this writing. As with the falls, crypto’s rises are shaped by traditional market forces and public opinion.

Whether we like it or not, cryptocurrency is becoming less decentralized. Crypto exists as part of a larger economic ecosystem and can no longer be isolated. Third party hosting of wallets, deposit of cash assets into traditional banks, public opinion, and inherent ties to fiat currency for trading impact the value of crypto. While the tech is better than ever (e.g., the Ethereum Merge[6]), crypto will be affected by centralized financial forces. Convenience and reliance on traditional systems will continue to plague cryptocurrency, subjecting it to the same market forces as traditional assets despite the original intent of full decentralization. Fully decentralized currency is a dream, welcome to reality.







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