This cryptocurrency winter may threaten the entire financial market

As the cryptocurrency market once again enters a winter, unlike previous cyclical fluctuations, this decline poses an unprecedented threat to the broader financial system due to the deep intertwining of digital assets with the mainstream financial system. The core of this risk lies not merely in price speculation, but in the systemic changes that aim not only to build alternative financial systems but also to penetrate traditional markets.

Bitcoin has fallen 30% in less than two months, erasing all gains for the year, while other crypto assets have seen even steeper declines. Alarmingly, this crash occurred in what is considered the most favorable regulatory environment in history.

The market has not utilized loose policies to build a robust system; instead, it has given rise to meme coins in the stock market, nearly unlimited leverage on exchanges, and frenzied prediction markets surrounding political events like government shutdowns. Even this week, an ETF tracking Dogecoin was listed on the New York Stock Exchange.

The most concerning and potentially riskiest area in this crisis is the rise of stablecoins. With a new bill known as the "Genius Act" providing credibility to the industry, stablecoins are rapidly expanding and being adopted by companies beyond the crypto space.

However, if this seemingly "stable" asset class faces a crisis of trust, the resulting sell-off will directly impact U.S. Treasuries and the money market, potentially replaying systemic risks similar to the 2008 financial crisis or the banking turmoil of 2023.

Lee Reiners, a researcher at Duke University's Financial Economics Center and former Federal Reserve official, warns that like money market funds and the repo market, stablecoins will inevitably face the risk of a run. Once investors panic and sell off, issuers will be forced to liquidate traditional financial assets held as reserves, thereby transmitting the chill of the crypto market to the entire global financial system.

De-leveraging and Discount Cycle

The current sell-off began with the collapse of excessive leverage and valuation bubbles. At the center of this round of declines is the Singapore-based crypto exchange Hyperliquid. This exchange has only 11 employees but handles an average daily trading volume of $13 billion and offers astonishingly high leverage services. In October of this year, the platform experienced a liquidation event of up to $10 billion, the shockwaves of which quickly spread throughout the market.

In the traditional stock market, publicly traded companies holding large amounts of crypto assets ("crypto treasury stocks") are becoming the biggest losers. Previously, market enthusiasm allowed these companies' stock prices to trade at a premium relative to their held crypto assets, with investors believing it reasonable to pay $2 for every $1 of cryptocurrency. This prompted companies to issue stock or take on debt to purchase more cryptocurrencies, thereby driving up prices.

Now, this trading logic is painfully reversing. The trading prices of these companies have fallen below the value of their held crypto assets, resulting in discounts. For these firms, the logical move has become to sell cryptocurrencies to buy back their own stock. This sell-off further depresses crypto asset prices, creating a self-reinforcing downward cycle

Expansion of Stablecoins and Entry of Traditional Giants

While the market is volatile, the stablecoin sector is showing signs of expansion, which in turn exacerbates potential risk exposure. As the closest crypto asset to an alternative financial system, stablecoins promise zero volatility by pegging to the dollar and have gained legitimacy through the new regulatory framework known as the "Genius Act."

This backdrop has attracted the participation of traditional business giants. Swedish "buy now, pay later" service provider Klarna announced this week that it will launch a stablecoin called KlarnaUSD next year. Previously, payment company Western Union and cloud service provider Cloudflare have also ventured into this field. Although the market is currently dominated by Circle and Tether—together accounting for a market capitalization of about $250 billion—new players like Klarna are entering the scene, particularly as their applications in overseas markets increase, leading to a closer connection between stablecoins and global business activities.

In countries with unstable currencies or capital controls, such as Argentina and Turkey, stablecoins have become the simplest way to obtain and transfer dollars. However, this widespread application also means that once a crisis occurs, the channels for its spread will become more diverse and globalized.

Redemption Crisis and Systemic Risk

Stablecoins typically maintain a 1:1 peg to the dollar by holding safe assets such as short-term government bonds, bank deposits, and money market funds. Ironically, these crypto assets rely on the traditional financial instruments they disdain to maintain stability. History shows that promising stability is much easier than achieving it.

This month, a small stablecoin operated by Stream Finance, which promised about an 18% yield, collapsed. The company went bankrupt after losing $93 million, leading to a market capitalization evaporation of about $200 million.

This case reveals the dark side behind the promises of stablecoins: bank runs. For investors, losing risk capital is one thing, but losing savings is another, and the latter can easily trigger panic withdrawals.

Even industry giants are not immune. Reflecting on the collapse of Silicon Valley Bank (SVB) in 2023, major U.S. stablecoin issuer Circle faced a bank run due to holding $3.3 billion in assets at SVB, causing its stablecoin price to drop to 88 cents at one point. Although Circle was ultimately saved by the regulators' promise to fully redeem SVB deposits, this exposed the fragile connection between stablecoins and the banking system.

Lee Reiners pointed out that SVB's failure stemmed from the depreciation of its ultra-safe government bonds in a rising interest rate environment. This contagion mechanism is precisely the current market's hidden concern. If investors sell stablecoins en masse, issuers will be forced to sell the underlying reserve assets such as government bonds.

Given that fluctuations in the government bond market have triggered multiple crises, stablecoins could become a new and unpredictable source of risk in the financial system. Just as a small crack in money market funds in 2008 led to a dark moment, people often only realize that risks have long existed after a crisis occurs