Crypto as an Asset during Wartime
How Russia-Ukraine War Macroeconomic Factors Could Impact Cryptocurrencies
Authors: Sofi Coen, Cameron King, Gabriel Perez, Rhett Miller, and Yuvraj Shah
Introduction
In 2009, Satoshi Nakomoto launched an innovative decentralized digital currency known as Bitcoin, birthing a new asset class that would become known as cryptocurrencies. Since then, cryptocurrencies have risen in spectacular fashion, growing to a market cap worth over a trillion dollars. From inception, many early cryptocurrencies were envisioned as a fundamentally independent currency, free from the governance of traditional monetary institutions and uncorrelated to traditional markets. Although many cryptocurrencies remain decentralized and neutral, they are not as uncorrelated as many would believe. Unlike the early Bitcoin era of cryptocurrencies, cryptocurrencies are no longer the impenetrable “safe haven” asset that many have claimed them to be. Likewise, other cryptocurrencies, particularly Ether, have taken up much of the market share that once belonged solely to Bitcoin. While crypto price volatility is nothing new, the 2020s saw tremendous impacts on cryptocurrency prices from covid, government regulations, retail sentiment, and much more. Such events proved that cryptocurrency prices are not necessarily independent, safe, or non-influenceable from state governments or traditional markets.
Today, global markets face unprecedented macroeconomic impacts from the Russia-Ukraine war. In late February of 2022, Russia invaded its neighboring state of Ukraine, resulting in worldwide socio-economic impacts, ranging from food shortages to decreases in global trade. The war has impacted federal monetary policy and the markets for many different assets, ranging from foreign currencies to grain. Such sweeping economic impacts are likely to impact cryptocurrencies, with wide ranging potential consequences on price. While future prices remain unpredictable, various factors including federal monetary policy, the pricing of crude oil, fluctuations in 10 year yield, Russian sanctions, and the collapse of the ruble are all likely to impact the price of cryptocurrencies in some way.
Central Bank Monetary Response
The Russian invasion of Ukraine began on February 23, 2022. Inflation had already been running rampant up until this point with CPI data reaching its highest levels in nearly 40 years. The Federal Reserve has stated they’re keen on reducing the inflationary burden that they have created for everyday Americans, but the concern is the war exacerbating macro trends already set in place.
Talks of specific sectors in the economy showing inflationary pressures more than others can be largely ignored when seen through the macro lens of there simply being more paper chasing the same amount of goods and services. Apart from changes in the federal funds rate, this has been the Fed’s main tool to stimulate the economy since the Great Financial Crisis. Quantitative easing is, in essence, a liquidity injection via the purchasing of bonds issued by the Wall Street banks. This mechanism fills the big banks’ balance sheets with an abundant amount of cash which then can be used to stimulate the economy via loans and asset purchases. The Fed’s QE has fueled the current financial boom we have experienced since the lows in 2020. On March 15, 2020, the Federal Reserve changed interest rates to zero and began adding fiscal stimulus. This drastic response and policy by the Federal Reserve was largely supported as the Covid-19 pandemic threatened “more damage than the 2007–09 Financial Crisis” (Ip, WSJ). The liquidity injections added over $5 trillion, and we are now witnessing the federal government implement a .25% rate hike (the first time since Dec. 2018). The additional rate hikes that will follow leads us to a 1.9% interest rate by the end of 2022. The Federal Reserve was forced to change their narrative of a “transitory inflation period” as inflation fears surrounded equity markets when inflation climbed above 7.9% annually in February 2022. This dramatic increase was far more than the Federal Reserve was originally expecting, as consumer demand across sectors increased alongside their fiscal stimulus.
The invasion of Ukraine has put the Fed in a difficult position of balancing economic growth while supply chain issues and inflation run rampant. The Fed, in their own words, has decided to be “wary” of the ongoing war yet remain committed to lift rates and slow inflation. Mary C. Daly, president of the Federal Reserve Bank of San Francisco, stated that she does not “see anything right now” that will intervene with the Fed’s planned rate hikes. This gradual raising of interest rates in the following months is an attempt to lower spending and reign prices in control without overbalancing and slowing down the economy to bring a recession. However, this balancing act has become complicated with consumer confidence declining in the United States and Europe since the war began. The Federal Reserve has said that the “long term implications from the invasion are highly uncertain.” However, what we do know is that the result of this invasion “will create upward pressure on inflation and weigh on economic activity”. The forecast for economic growth has already decreased to 2.8% from the 4% that was proposed in December. This will undoubtedly cause the Federal Reserve to be more aggressive in rate hike and reduce federal spending to control the multiple macro-events weighing the economy down.
The prospect of future interest rate hikes will create more volatility across asset classes. Categorizing crypto as a non-cash flow generating asset or high growth asset puts extra pressure on short-term price. However, since the announcement of .25% interest rate hike on March 15, equities across the board and crypto have seen buying pressure. Investors speculate that this rate was largely priced in, adding extra weight to the future rate hikes and the volatility that could ensue. The question of how cryptocurrencies will perform as an asset class throughout their first war environment, therefore, depends largely on inflation and interest rates.
The Fed’s asset purchases have continued to increase since the date of the invasion, circled in red. Their justification is most likely to support the economy as consumer confidence remains unstable given the ongoing war.
Ethereum vs Crude Oil
The economic sanctions on Russia have isolated the world’s second largest exporter of oil on the global stage. Russia exports around 8% of the global oil supply; strict sanctions from the West are likely to tighten the global supply of oil products. This comes in conjunction with the already devaluing petrodollar from a continuous stream of printed money. These events have resulted in consequences manifested mainly through the surging price of crude oil. The price of WTI crude oil shot up nearly 40% in the two weeks following the invasion.
Although not reliant on oil, both Bitcoin and Ethereum utilize proof of work (PoW) consensus mechanisms, which are reliant on computing power and energy to secure their respective blockchain networks. So how did they respond?
Global hashrates on Ethereum remain undisturbed from their linear trajectory:
With that being said, Ethereum and WTI crude oil appear to have an inverse relationship when it comes to price action. This could be due to Ethereum being linked as a speculative asset in the short run, with higher energy costs increasing cost of doing business.
Ethereum vs 10 Year Yield
Ethereum is often referred to as a speculative asset, which may or may not be the case depending on who you ask. As a speculative asset, Ethereum’s price would in theory be vulnerable to changes in the 10-year yield. A higher interest rate makes it more costly to borrow, which dampens the growth of the small cap market. Although this may be the case for speculative companies in the stock market, Ethereum is not a company. It’s a network.
So far, it’s shown remarkable correlation with the 10-year yield. One theory is that high interest rates increase the cost of borrowing money, therefore, it becomes more economic to obtain funds via decentralized solutions. Ethereum surely benefits from the network effect, where more users boosts the value of the underlying network.
Financial Sanctions Imposed on Russia
Out of all the sanctions imposed on Russia, perhaps the most brutal of the lot presents itself through the temporary ban of select Russian banks from the Society for Worldwide Interbank Financial Telecommunications (SWIFT) payment system. This system functions as a vast messaging network that enables thousands of banks and financial institutions around the world to quickly, securely and accurately obtain information about the transfer of money. To put things into perspective, the system was responsible for propagating over 42 million transfer instructions on a daily basis in 2020. Hence, by banning these select Russian banks from the system, the EU and its allies were able to freeze their ability to transact with the rest of the world in an attempt to paralyze the Russian economy by freezing international trade and the finance sector. A large contributor to the paralysis of the Russian economy may be attributed to their inability to receive payments on their exports of oil and gas, which contributes approximately 40% to their revenue per annum.
Moreover, the US, EU and its allies have also frozen approximately $650 Billion of Russian foreign reserves, which was believed to be the “war chest” that would fund their invasion into Ukraine. However, there have been concerns surrounding Russia’s potential use of cryptocurrencies to get around the sanctions being imposed on them. As previously established, cryptocurrencies are decentralized, global, and permission less currencies. Thus, sanctions imposed by the United States or other powerful nations are not enforced through cryptocurrencies. As cryptocurrencies operate on a globally distribute ledger, it is possible for Russia to continue to receive and send cryptocurrency payments, possibly in exchange for goods. Although the exact extent of Russia’s cryptocurrency usage remains unknown, there is no doubt that cryptocurrencies present an alternative, albeit imperfect, method of payments to engage in a global system.
Collapse of the Ruble
Given the subsequent isolation of the Russian economy as a result of the financial sanctions, the Russian Ruble collapsed by more than 40% within a matter of days. To make matters worse, Russia imposed a set of capital controls on their citizens that would restrict their ability to preserve their wealth. Exporters were required to sell 80% of their foreign currency to the central bank. There was a $10,000 limit on Russian withdrawals in USD over 6 months, a $5,000 limit on sending money abroad and a ban on buying foreign stakes in domestic assets. Capital controls like these make it evident that the most brutally impacted stakeholder in a situation like this would be the average Russian person, who is forced to witness the diminishment of his/her wealth due to the falling Ruble.
A problematic situation like the one presented above only reinforces the necessity for a decentralized financial network that protects the wealth of the masses during trying times like these. The following charts present the prices of the Ruble and Bitcoin during Russia’s invasion of Ukraine and the establishment of financial sanctions on Russia:
Neutrality of Crypto
As cryptocurrency continues to find its way into more and more people’s lives, the real world utility of the decentralized currency becomes greater. Especially since Russia announced its war against Ukraine, crypto has shown why it has the competence to survive and thrive in the modern world. One of the greatest reasons why many people choose to adopt cryptocurrency is because of how it is decentralized and not connected to a government. This utility has proved itself invaluable, especially in comparison to the falling price of the Russian currency ruble as crypto prices were less affected by macroeconomic factors. Additionally, the advantage of crypto within a wartime economy is the speed at which transactions can be made and money can be sent from one person to another. A donation in crypto can take seconds to transfer while bank transfers can take hours, even days.
One of crypto’s most outstanding use cases has been highlighted in the form of DAOs. A DAO, standing for decentralized autonomous organization, is essentially a community wallet funded by a group of people with the purpose of pooling money together to achieve a common goal. DAOs can be used for a multitude of things, from investments to grants to donation pools. One of the largest community donations to aid struggling Ukraine citizens was the Ukraine DAO, a wallet to receive cryptocurrency charitable donations in the form of bitcoin, ethereum, and virtually any other coin. Ukraine DAO’s mission is “Using the power of web3 tech and community to raise funds for Ukrainian organizations that are helping Ukraine defend itself from the Russian aggression.” Since the beginning of the war a month ago, DAOs like this have raised over 100 million dollars worth of crypto for Ukraine, showing the unprecedented capabilities and potential of the blockchain. As the popularization of crypto has skyrocketed in the past year, it has opened new paths to raise money for important causes that target younger people who are generally more tech savvy, but less aware of their political surroundings.
Conclusion
In Summary, the Russia-Ukraine war has resulted in various macroeconomic factors that present varying potential impacts on cryptocurrency prices. Despite possible price volatility and wartime pressures, cryptocurrencies have stayed true to their central tenets of neutrality and decentralization, offering benefits to both Ukraine (through solutions) and Russia (an alternative to the weak ruble). However, the Russia-Ukraine war is not the sole influence on cryptocurrency price movements. In recent months, the cryptocurrency markets have experienced a dip, with both Bitcoin and Ethereum dropping to well under 50% of their all time highs. Although many factors contributed to this dip, perhaps the most unexpected was the failure of Terra. A failure in Terra’s complex algorithmic stablecoin system, balancing UST and Luna, ultimately resulted in a depegging of the stablecoin and price crash of Luna, resulting in a loss of $40 billion dollars in Luna alone. Indeed, while the Russia-Ukraine war will no doubt have tremendous impacts on cryptocurrencies, the fact remains that many cryptocurrencies are often treated as speculative and volatile assets whose price can go any which way for any number of reasons. It is prudent to consider this volatility and variety of market factors in any cryptocurrency analysis, including the analysis provided in this article.
