The chatter surrounding the timing of the next recession is only getting louder, with two-thirds of economists now predicting that we will see some sort of economic downturn by the end of 2020. As we prepare for what many consider to be the inevitable, I’m frequently asked by investors and colleagues: “How will a future recession impact the cryptocurrency industry?” My unsatisfying answer: “We can’t really be sure.”
This new, decentralized asset class was born at the tail end of the housing crisis, and has yet to experience the full force of a recession or even lengthy bear market. What I can say with certainty, however, is that few industries will have more to learn and more to teach: because not all 2,000 cryptocurrencies are alike and, as such, not all 2,000 cryptocurrencies will respond the same way to market pressure.
For years, digital assets have existed in a period of market expansion in the United States. Gross Domestic Product (GDP) has increased significantly, bringing total average GDP growth from -1.73% in 2009 to 3.138% in 2017; and unemployment has dropped from 10% to 4%, with more than two million jobs created each year for the past eight years.
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Unfortunately, what’s been a positive sign for upward trends in traditional markets has had an adverse impact on the mainstream appeal of digital assets.
Because the economy has steadily improved throughout the industry’s life-span, some more casual observers have failed to fully appreciate how the intrinsic qualities of blockchain-based assets (e.g., decentralization, immutability, and bespoke structures) may benefit them. As a result, many have erroneously assumed all digital assets are functionally interchangeable, and will all react the same way to economic fluctuations.
As is the case with any industry, companies weathering the impact of a severe market correction are, understandably, going to react differently based on their business models, leverage, and market capitalization. That’s not to say we’ll know exactly what will happen during a recession—it’s perfectly plausible, if not likely, that there will be at least some material degree of performance correlation between various digital assets. However, what’s more likely is that we’ll begin to see certain digital assets, each equipped with their own unique value proposition, begin to separate themselves from the pack and gain momentum as a result of their inherent structural value, not merely from speculation or the rising tide of a bullish crypto market.
To illustrate this, I believe it’s important to analyze how a recession might impact three largest digital assets by market capitalization: Bitcoin, Ethereum, and Ripple. Faced with a recession, Bitcoin may serve a market function similar to that of a safe-haven commodity, rather than an equity, due to its inherent scarcity and decentrality. Bitcoin, by design, is not intended to be used as a foundation on which developers could build a platform or enterprise. Because its supply is not controlled by any one person or entity, it’s more likely that Bitcoin will perform independently of broad market pressures (akin to how one would expect gold to react)—potentially even appreciating in value should demand for alternative forms of dependable value storage arise.
By contrast, Ethereum is far more likely to follow market trends. That’s because its platform allows other companies to build products on top of the Ethereum protocol, putting significant onus on mainstream investors to keep products afloat. If the investors suffer, the companies suffer, which causes Ethereum to suffer as a result. Because Ethereum is a developer-focused blockchain, it’s very much dependent on how many companies use the Ethereum platform to build their projects. If those companies were to go out of business, Ethereum’s relevance and, subsequently, its price, would undoubtedly be affected. That’s not to say Ethereum is structured similarly to equity markets by any means, but it’s more closely entangled with equity markets than most other digital assets.
Which brings us to Ripple’s XRP, a payments-focused digital asset that currently has the third largest capitalization in the crypto industry. Unlike Bitcoin and Ethereum, Ripple digital currency is frequently used for frictionless financial asset transfers, functioning more as a medium of exchange than other digital assets. Because XRP functions outside the purview of mainstream markets, it’s certainly reasonable to believe that XRP would act independently in the event of a recession. On the other hand, however, XRP’s price is also highly dependent on issuance and adoption. If Ripple loses usership—either because its issuance was mismanaged or because other projects (such as J.P. Morgan ’s new coin JPM) became more popular—XRP’s value would almost surely go with it.
So what does this mean for the long-term future of digital assets? Recessions are evolutionary bottlenecks in the world of modern economics—where weak projects expire, strong projects prevail, and industries become more resilient as a result. Recessions clean out the companies that rely solely on investor speculation and market interest to be successful; they simply won’t be able to survive the headwinds. Although the surviving pool of companies will be smaller, it will also be less crowded and filled with more substantive projects. If people think a product is worthwhile even when money is tight, it’s certainly indicative of its long-term value. Whether or not a recession lurks around the corner, the digital asset industry is overdue for a moment when users begin to recognize projects for their unique value propositions, not just their existence in the larger crypto market.
Author: Kyle R. Chapman