Federal Reserve Bank of Chicago: Large Crypto Whale Withdrawals Spark US Banking Crisis
In a recent analysis, the Federal Reserve Bank of Chicago (FRBC) has identified large withdrawals by institutional crypto investors as the catalyst for a severe liquidity crisis that has put the traditional banking system in the US under strain. The liquidity crunch caused by these withdrawals has resulted in the collapse of three banks in the country.
According to the FRBC, the downfall of several prominent crypto projects, including BlockFi, Celsius, FTX, Genesis (in partnership with Gemini), and Voyager Digital, has had a significant impact on the ongoing banking crisis. The collapse of Terra, a major player in the crypto market in May 2022, acted as a trigger for turbulence within the sector. The loss of equivalence of Terra's native stablecoin, UST, to the US dollar led to financial risks for its holders and subsequently caused a crash in the market. During this time, Terra's LUNA and UST tokens reportedly lost approximately $45 billion within just three days.
As a result of the liquidity crunch and market downturn, several crypto firms were forced to lay off employees in order to sustain their operations. Three Arrows Capital, Celsius, and Voyager, among others, eventually filed for bankruptcy due to significant outflows of funds.
The FRBC's report highlights how these platforms attracted customers by offering high-yield investment products with easy fund withdrawal options. However, these firms utilized customer funds for illiquid and risky investments, aiming to generate the promised high returns. When negative shocks hit the market, customers had an incentive to withdraw their funds to avoid incurring losses, which ultimately affected the stability of these platforms.
Within a short period last month, three large crypto-friendly banks in the US succumbed to market pressure and collapsed. Regulators deemed their unstable status as potentially posing a severe threat to the US economy. In response, authorities announced that custodians linked to these failed banks would have access to their funds to mitigate the financial damage.
The FRBC study emphasizes that while crypto-asset activities are often regarded as unregulated, many crypto firms actually try to circumvent the existing regulatory system, which would require them to disclose crucial financial risks associated with their products. This lack of regulation and transparency contributed to the bankruptcy filings of these platforms.
The current state of both the crypto market and the overall financial sector is characterized by volatility. Furthermore, the consecutive interest rate hikes by the US Federal Reserve have added to the existing pressure on the financial market, including the crypto sector.
The valuation of the crypto sector has significantly declined from its peak of $3 trillion to the current market capitalization of $1.14 trillion, according to CoinMarketCap.
Market pressure and financial sector volatility:
The overall financial sector, including the crypto market, is currently experiencing significant volatility. The Federal Reserve's interest rate hikes have added additional pressure to the already fragile financial market. The valuation of the crypto sector has plummeted from its peak of $3 trillion to approximately $1.14 trillion, reflecting the overall decline in market capitalization.
the large withdrawals made by institutional crypto investors have played a substantial role in the US banking crisis, leading to the collapse of several banks and causing significant instability in the traditional banking system. The impact of these withdrawals, combined with the overall volatility in the financial market and the absence of proper regulation in the crypto sector, has created a challenging environment for both investors and financial institutions.
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