On August 30, global investment bank UBS raised its assessment of the risk of the United States sliding into recession within a year from 40% in June to 60%. According to economist Pierre Lafourcade, the latest data showed a 94% chance the economy was contracting, but added that it “is not turning into a full-blown recession.”
The difference can be explained in part by the “extremely low levels” of non-performing loans, or borrower defaults of more than 90 days. According to Jane Fraser, Citigroup’s Chief Executive, “The institution is feeling ‘very good’ on liquidity and credit quality. In addition, Reuters states that the financial industry wrote off only 0.1% of its loans in the second quarter.
The problem is that even in the now unlikely scenario of avoiding a general recession, companies will face falling profits as rising inflation limits consumption and central banks raise interest rates while shedding their balance sheets. In any case, the pressure on corporate earnings is enormous and this is putting pressure on share prices.
The valuation dynamics for cryptocurrencies are very different from stocks, corporate bonds and equity markets. The truth is that there are no set metrics or indicators to determine token prices. Market participants have different perspectives on the protocols and their use cases.
On the other hand, the stock market has battle-tested valuation indicators that have been consistently used and pounded by analysts, pundits, and investors for decades. For example, the price-earnings multiple measures how many years it would take for a company to generate enough profit to cover its current market capitalization.
Regardless of how you measure stock market success, it depends on margins, sales, interest rates and the US dollar exchange rate. Because of this, a stock can fall 70% or more even before a recession hits the markets, as it badly needs a steady stream of income. It is unlikely that the same reasoning is applicable to crypto?
Understand stock markets and commodity valuation
The first rule of stock valuation is that investors have different inputs, expectations, and time frames for a stock. Sure, there are consolidated models, indicators, and analyst recommendations, but ultimately there’s no guarantee the stock price will follow any logic.
We can graph the price/earnings multiple, enterprise value/EBITDA, or other metrics that investors watch closely. However, one never knows what the future holds for these companies, even those with long-term contracts, such as the energy sector.
Traders should not confuse volatility with valuation. A company can have steady and predictable cash flow, but that could become a drag during bull markets when other sectors are increasing earnings and expanding. Additionally, a stock market price is never immune to the broader economy, as the collapse of a financial institution could ultimately drag down counterparties as well.
Let’s take a simple and utopian example, the New York real estate market. When development stalls, nothing changes in the usability of the land, including homes, commercial, and agricultural land. If a deepening crisis causes the rupture, there is even room for price gains as some investors would seek protection in hard assets.
The same goes for oil, gold or cattle. A constant flow of income is not required to maintain the value of these assets. Worst-case scenario, gold and oil will stop being mined, but their price is likely to rise as the supply currently available decreases.
What are cryptocurrencies?
It doesn’t matter whether investors view Bitcoin (BTC) and Ethereum (ETH) as commodities, currencies, or bets on emerging technologies. Both assets have extremely limited production schedules that will be met even if the hashrate and validators (nodes) drop by 90%. Their use as independent transmission systems for digital assets will continue to function as planned.
As mentioned earlier, the price of cryptocurrencies could be heavily impacted by an ongoing economic recession, but there is hardly a scenario where the networks become unusable due to inflation, rising interest rates, or defaults on loans. The same rule can’t be applied to Walmart, UnitedHealth Group, or Ford Motor Company — all top 20 companies by revenue.
Paradoxically, failing companies are not a viable store of value during a recession, meaning bankrupt assets can be liquidated and the shareholder receives zero. The decentralization aspect of cryptocurrencies protects investors from even the worst-case scenarios, including being delisted from major exchanges.
At the same time, the initial shock of a global recession, such as the housing market collapse and growing distrust in the financial system, could pave the way for alternative hard assets, including cryptocurrencies.
It sounds like a distant dream right now, but a full-blown recession would be the first major global financial crisis cryptocurrencies would experience since Bitcoin’s inception in 2009.
Whether crypto valuations will hold up over the long term remains to be seen. To date, the sector has suffered major defaults from market participants, including exchanges and credit intermediaries, and no intervention has been required during this time. It could thus be said that it has passed its first test, although it is still too early to present the final report.
The views and opinions expressed herein are solely those of the author and do not necessarily reflect the views of Cointelegraph. Every investment and trading movement involves risk. You should do your own research when making a decision.
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