Crypto’s Identity Crisis

Cryptocurrencies have experienced many changes since Bitcoin emerged in 2009. The latest slump has once again raised questions about their place in the world.

In April 2022, Fidelity Investments became the first financial services company to allow retirement savers to include Bitcoin in their 401(k) accounts,1 evidence of just how widely cryptocurrencies have been adopted in recent years. Fidelity is the largest retirement plan provider in the U.S., managing employee benefit programs for almost 23,000 companies and some 40 million individual investors, with a combined $11.8 trillion in assets. The big investment manager is not new to cryptocurrencies; in 2018, it launched Fidelity Digital Assets to provide cryptocurrency products and services to institutional investors.

Early this year there were other signs that crypto had gone mainstream. Investors bought and sold the currencies in large amounts.2 Crypto advertising was ubiquitous., a Singapore-based exchange, rolled out an aggressive television marketing campaign and bought the naming rights to Los Angeles’s Staples Center; Bahamas-based crypto exchange FTX put its name on the Miami Heat’s arena and the uniforms of Major League Baseball’s umpires.3

Evidence of crypto’s adoption abounded. Exchanges converted fiat currencies into virtual currencies, and bitcoin ATM kiosks appeared in stores. Elon Musk not only tweeted regularly about crypto, his electric car company, Tesla, accepted bitcoin as payment. PayPal offered crypto functionality, El Salvador adopted Bitcoin as legal tender, and U.S. regulators approved four Bitcoin exchange-traded funds. Cryptocurrencies were even used to raise money to help the Ukraine military after Russia’s invasion,4 and they funded the EndSARS demonstration against police brutality in Nigeria.5

That boom has since faded. And crypto, mired in a downdraft, struggles with large and fundamental questions: What will crypto look like as it grows up? And how will it fit into the already existing financial, data, accounting and regulatory systems? As European Central Bank chief Christine Lagarde told a Dutch TV interviewer in late May, crypto assets “are worth nothing, based on nothing, and there is no underlying asset to act as an anchor of safety.”6 Even Sam Bankman-Fried, the founder of FTX and a recent investor in Robinhood Markets and troubled crypto lender BlockFi, told the Financial Times that Bitcoin was not capable of scaling up sufficiently to handle millions of transactions. “The bitcoin network is not a payments network or a scaling network,” he said.7

Lagarde and Bankman-Fried were responding to a significant crisis in crypto: By early May 2022, $1 trillion in the currency’s value had evaporated, and the slump deepened from there. In mid-June, the price of bitcoin, which had increasingly mirrored the broader stock market, fell below $20,000, a decline of more than 70 percent in just seven months. More perilously, some stablecoins — crypto tokens priced at $1 a share — broke their dollar peg and imploded. One stablecoin, TerraUSD, collapsed to mere cents on the dollar, sending panic through the ranks of other stablecoins, including one of the largest, Tether. And big crypto lender Celsius Network first suspended withdrawals, then declared bankruptcy, as did a smaller lender, Voyager Digital.

The recent slump is part of a larger revaluing of assets as risk has risen throughout the financial system as a result of inflation, rising interest rates, increased regulation, war, an energy crisis and post-pandemic growth concerns. In the markets, crypto is just another risk asset responding to the surge in economic and financial risk by falling in price. Crypto’s deepening interconnections with the conventional financial system, and its rapid growth (though it still remains far smaller than mainstream asset classes), stir fears of macroeconomic instabilities and systemic risks.8 Not surprisingly, various efforts to regulate crypto have gained momentum, reining in a financial technology whose original purpose was to free itself from governments.

This, then, is a good time to revisit the debate over crypto, which has been blessed (or burdened) with an array of different functions since Bitcoin’s launch during the 2008–’09 financial crisis. It has been treated as a currency, a medium of exchange, a store of value, a speculative instrument, a payment system, a technology for secure storage, an instrument of financial liberation, a platform serving various emerging metaverses, a decentralized trading platform, and even the next incarnation of the internet, so-called Web 3.0. That’s a lot for a new set of technologies to support, reconcile, and justify.

Evolution and Revolution

The crypto landscape has evolved rapidly. As of August, more than 20,000 cryptocurrencies were in circulation, ranging from Bitcoin to thousands of different “altcoins” (including stablecoins, meme coins, and security, governance and service tokens). Between January 2020 and January 2021, the number of cryptocurrency wallets in use worldwide increased 45 percent, to an estimated 66 million. Bitcoin accounted for 40 to 50 percent of the total value of all cryptocurrencies, compared with 70 percent in January 20219 — a decline attributable to the increasing popularity of other altcoins.10 In 2021, the Bank for International Settlements (BIS) estimated that owning a cryptocurrency during one year increased the probability of owning crypto the following year by 50 percent.

The extraordinary growth of the crypto ecosystem has been driven by technological innovation and fueled by rising institutional and retail investor interest. According to blockchain data platform, global adoption of crypto increased by more than 2,300 percent between third quarter 2019 and second quarter 2021. The growth has nurtured the emergence of decentralized finance (DeFi): a global network of secure distributed digital ledgers, in which financial transaction data is recorded in multiple places at the same time without the intervention of intermediaries.11 DeFi works off “smart contracts” — programs stored on a blockchain that run when predetermined conditions are met.

There’s also been a growing acceptance of cryptocurrencies for payment purposes in both developed and emerging markets. In the developed world, transacting through the blockchain offers the promise of speed, efficiency and a degree of anonymity. In the developing world, it provides a way around exclusionary legacy financial systems12 and a lack of access to centralized exchanges. As a result, peer-to-peer (P2P) crypto exchanges have developed to facilitate cross-border transactions, enabling, in theory, lower transaction costs, faster processing and high levels of privacy.13,14

Still, DeFi and payments are only two aspects of crypto. Cryptocurrencies like Bitcoin and Ethereum are primarily viewed as investment products. These currencies now include a dense array of investible instruments, technologies and structures. However, no one really knows where this diverse asset class or the broader financial technology is going, or whether it’s sustainable over the long run.

In recent years, crypto adoption in North America, Western Europe and East Asia has been driven largely by institutional investment. Although advanced economies such as the U.S. are technologically better prepared for the adoption of crypto assets, emerging market economies have taken to crypto more quickly. Nine out of 10 major adopters are emerging market countries.15

Crypto usage tends to be higher in countries with a history of financial instability or where barriers to traditional financial products, such as bank accounts, are high. Developing economies suffer from bouts of inflation and fast-changing exchange rates, expensive banking systems, financial restrictions and regulatory uncertainties, especially the existence (or threat) of capital controls.16 Currency devaluations may prompt individuals to buy cryptocurrency on P2P platforms to preserve their savings. In these countries, cryptocurrencies are often used for cross-border transactions such as remittances or to purchase goods.17 Africa has the largest proportion of retail crypto users with transactions under $10,000; Nigeria is one of the biggest crypto remittance markets.

For most of the years following Bitcoin’s creation, crypto prices moved independently of stocks and sometimes even seemed to trade in opposition to stocks — so-called negative correlation. That was long viewed as a virtue, allowing bitcoin to act as a hedge, like gold, against equity downdrafts. But that changed in 2020. Through the initial pandemic market plunge, steep recovery and economic turbulence, Bitcoin and other digital tokens swung from a negative to a positive correlation with stocks.18 Today, Bitcoin is even more tightly linked to stocks. According to Wolfe Research, the exception is a handful of so-called meme tokens, such as Dogecoin or Shiba Inu; they don’t appear to be correlated, and Shiba Inu has a negative correlation.19

Why has this shift occurred? We will explore this further below, but currently the most popular thesis is that mainstream adoption has nurtured a growing interconnectedness between Bitcoin and traditional asset classes. That’s just a hypothesis, however, because Bitcoin’s history is relatively brief and crypto has never experienced a period of high inflation, flagging growth, and rate shocks — up until now.

Birth of Bitcoin

If the public knows anything about crypto, it’s Bitcoin. In fact, “bitcoin” is often used as shorthand for the larger crypto ecosystem. Bitcoin is the oldest surviving cryptocurrency and remains the biggest by value. Launched in 2009 as an open-source software application, Bitcoin initially was embraced by computer experts, political activists, and other groups that had lost faith in established financial institutions. In the early days, individuals “mined” Bitcoin as a hobby, completing calculations to “earn” new Bitcoin.

Rising adoption drove an increase in the number and size of Bitcoin miners, necessitating extensive computing resources and more energy-intensive mining processes. New mining facilities led to overloaded energy networks and occasional outages. Bitcoin mining used electricity at a rate exceeding the entire annual energy consumption of Egypt, Norway, Poland and Ukraine,20 consuming some 0.63 percent of total global electricity and 0.21 percent of total global energy. That heavy electricity consumption spurred significant regulation. China banned Bitcoin mining in June 2021, driving miners to countries with fewer regulations, including the U.S. But even in the U.S., regulators including the Securities and Exchange Commission (SEC) have promised a raft of new rules for the industry, a development that’s grown likelier as the losses and failures have mounted.

Much of Bitcoin’s popularity has stemmed from its status as a potential store of value — a kind of digital gold. In theory, Bitcoin’s value has been driven by the reality that over time only 21 million coins will be mined. In December 2021, International Data Group analyst Madana Prathap estimated that 90 percent of all Bitcoins had already been created and that new Bitcoins were unlikely after 2140.21 Another expert, crypto author Roy Fantass, predicted that 99 percent of all Bitcoins would be mined by 2032.22 This finite supply and rising demand appeared sure to drive up Bitcoin prices over time.

In fact, rising Bitcoin prices are indeed part of the cryptocurrency’s trading history, though that history has also been characterized by significant volatility. Bitcoin was first used in a commercial transaction in 2010, when two pizzas were bought for 10,000 bitcoin. The value of 10,000 bitcoin had increased to approximately $35 million (at $3,500 a bitcoin) by December 2018, risen to around $350 million by August 2021 ($35,000 per bitcoin) and climbed to $670 million ($67,000 per bitcoin) by November 2021. A 2022 research report by ARK Investments argued that the price of one bitcoin could exceed $1 million by 2030.23

Bitcoin as Investment Product

Recent developments have made it more difficult for both individual and institutional investors to ignore Bitcoin. In late 2020, Deloitte estimated the number of U.S. businesses using Bitcoin, excluding bitcoin ATMs, at more than 2,300.24 In the first quarter of this year, BTCS, a company focused on blockchain technology, paid the first-ever bitcoin dividend to its shareholders.25 As of early 2022, there were between 150 and 200 active crypto hedge funds; PwC says high-net-worth individuals and family offices are the largest investors in these hedge funds.26 To offer investors ways to buy and store Bitcoin and other digital assets, global banks including JPMorgan Chase, Mitsubishi UFJ Financial Group, Morgan Stanley and Goldman Sachs have started bitcoin-linked funds.

Bitcoin may be the most popular cryptocurrency, but it is just one of a growing number of instruments and vehicles that possess varying attributes of liquidity, currencies, property, securities, and even art. Altcoins are attempts to “improve” one aspect or other of Bitcoin. Defining what these coins and tokens are will determine the nature of crypto regulation and the bodies that undertake it. The BIS has described the motivation for the creation of cryptocurrencies as the desire to develop an alternative to fiat money and commercial banking, with the goal of creating a new form of exchange, resistant to debasement and censorship by governments and financial institutions. Cryptocurrencies differ from fiat currencies because of their unique combination of features: anonymity, independence and the blockchain’s ability to time-stamp transactions, making them irreversible.27

This complexity poses a significant regulatory challenge. Increasingly, governments are trying to grasp the benefits and risks of digital currencies, to counter competition for their fiat currencies and to provide faster and more efficient means of payment. A variety of central bank digital currencies (CBDCs) have been launched by, among others, China (with its digital currency electronic payment, or DCEP, and its digital renminbi, or e-CNY, the former a decentralized digital currency, the latter issued by the central bank and not used on the blockchain), Sweden (e-krona), the Eastern Caribbean Central Bank (digital Eastern Caribbean dollar, or DXCD), the Central Bank of the Bahamas (sand dollar)28 and Nigeria (e-naira).

Cryptocurrency Benefits and Drawbacks

Through the use of blockchain’s distributed ledger technology, cryptocurrency systems are designed to protect users’ data from manipulation. Users can send only cryptocurrencies they have access to; this allows valid transfers without a centralized, trusted intermediary. Indeed, freedom from intermediaries — including lawmakers and central banks — has become a powerful ideological argument for the technology.

Cryptocurrencies provide features not available with fiat currency. For example, programmable money — that is, digital currency — can enable real-time and accurate revenue-sharing while enhancing transparency that facilitates back-office reconciliation.29 Cryptos are best known as investment vehicles, with owners buying and selling as their assets’ value rises and falls. Bitcoin has been declared a digital hedging instrument against country-specific risk, inflation or the breakdown of traditional financial assets such as stocks and bonds.30

With its blockchain technology, Bitcoin sidesteps intermediaries like clearinghouses, which makes it independent of sovereign risk.31 Bitcoin transfers can be made without reliance on counterparties or trust relationships and without getting authorization from a company or government.

But crypto has its dark side, which often seems inextricably linked to its virtues. Its anonymity makes it attractive to those operating outside the law, enabling money laundering, arms and drug sales, and ransomware. Thefts of digital wallets occur regularly. Regulatory arbitrage can arise32 from P2P platforms offering products that exist outside legal frameworks, and this can lead to the buildup of risk. Because of the relatively unregulated nature of crypto markets, significant disruption driven by cryptocurrency price volatility may lie beyond the control of central banks and regulatory authorities.33

Crypto’s anonymity and pseudo-anonymity have been seen as a much-touted strength, but they prevent transactions from being monitored. A tax authority, for instance, can’t levy a tax if it doesn’t know who has entered into a taxable transaction.34 The U.S. Internal Revenue Service has issued guidance that virtual currencies should be treated as property (rather than currency) for tax purposes, but that doesn’t really resolve the larger problem. Regulators such as the SEC have released investor alerts and press releases on charges against scams and frauds, and have studied more sweeping regulatory reforms, but it’s unclear whether the SEC or the Commodity Futures Trading Commission will take a lead in overseeing crypto.

With no central authority to verify transactions, many investors have been skeptical of bitcoin and other cryptocurrencies, and reluctant to use them. Though cryptocurrencies continue to gain some acceptance as a payment option, price volatility has discouraged their use in purchasing goods and services.35 In fact, while volatility has fed speculative trading, it has limited crypto assets’ use as a means of payment, store of value or unit of account.36

The Correlation Problem

Crypto has been used most prominently as an investment, trading, diversification and hedging vehicle, but in the past year or so all these uses have been questioned. One sign of trouble can be found in crypto’s shift from a negative to a positive correlation with stocks. As the market value of bitcoin rose at the end of 2017, its performance showed little correlation with stock indices. But by the second quarter of 2020 that correlation had flipped, with both bitcoin and U.S. stock prices rising against the backdrop of easy global financial conditions and increased investor risk appetite, according to Tara Iyer, an economist at the International Monetary Fund.37

Since then, bitcoin has continued to show strong positive correlation with macro assets, including U.S. tech stocks, crude oil and government bonds — albeit with a trading pattern that some have compared to the sawtooth haircut of Bart Simpson.38 For example, on September 26, 2021, the price per Bitcoin was $42,376 and the S&P 500 was at 4455. On November 9, 2021, Bitcoin was up to $67,413 and the S&P hit 4685. On January 22, 2022, Bitcoin fell to $35,471 and the S&P fell to 4397. Bitcoin’s intraday price volatility became more closely correlated with the volatility of the S&P 500, Nasdaq and Russell 2000 indices than in 2017–’19. The same applied to emerging markets, where the volatility correlation between bitcoin and the MSCI index increased between the pre- and post-pandemic periods.

One explanation for the positive correlation between Bitcoin and tech stocks is that both are affected by macro factors such as interest rates and inflation. With rates very low, crypto and risk assets like tech stocks can justify high valuations. But with inflation pushing rates higher, the valuation of risk assets has come under pressure as the time required to meet growth targets has lengthened. Over time, tech stocks, of course, reflect the underlying growth of tech companies. For the most part, Bitcoin and other major cryptocurrencies lack that underlying source of value. They’re purely speculative, which in turn feeds volatility.

Despite these shifting correlations, fluctuations in Bitcoin often appear idiosyncratic. Many factors play a role in this volatility, including (but not limited to) institutional adoption, retail investor speculation, regulatory changes and excitement around new technologies.39 Part of that idiosyncratic risk is that crypto is still new, still evolving and still going through adoption. Whatever the reason, this high and mostly idiosyncratic volatility can, over time, make Bitcoin a risky bet and difficult to include in multiasset portfolios or use as a hedging or diversification tool.

According to the IMF, this positive correlation has the potential to feed financial contagion — the rapid spread of distress from one asset class to another. The growing interconnectedness between bitcoin and more-traditional asset classes may facilitate the transmission of shocks that can destabilize financial markets. Indeed, just as the Federal Reserve was beginning to engage in quantitative tightening in June 2022 — draining some $9 trillion in assets off its balance sheet — Bloomberg’s Market Live Pulse (MLIV), a weekly survey of investors, tagged bitcoin and tech stocks as the two risk assets most vulnerable to the end of ultra-cheap money.40 Spillover risk tends to increase in times of market volatility, such as the March 2020 market turmoil, when stocks fell 35 percent and bitcoin plunged nearly 50 percent as the pandemic hit, and the broad declines of 2022.

The positive correlation between cryptocurrencies and the S&P 500 makes Bitcoin less useful as a portfolio diversification tool in times of crisis.41 Historically, Bitcoin has served at times as a way to diversify from, say, stocks, though this was episodic due to the volatility in bitcoin prices.42 In a 2021 report, Goldman Sachs argued that because Bitcoin’s history was too short to cover a full business cycle or period of high inflationary pressures, it was unclear how Bitcoin would perform in a high-stress environment. Now we’re beginning to get more information.

Bitcoin may have lost its ability to serve as a gold-like safe haven vehicle in times of financial market uncertainty.43 For risk-averse investors, excessive exposure to bitcoin may increase the probability of losses in extreme market conditions.44 In fact, over time, crypto has become negatively correlated with gold, shattering an article of crypto conventional wisdom, as a June 2022 Bloomberg Opinion column concluded: “Gold and Bitcoin are opposite solutions to a lack of faith in currency. Gold is simple and tangible, and supported by thousands of years of history, and no theory. Bitcoin is complex and abstract, supported by 14 years of extreme volatility, with a great theory. Gold requires no infrastructure; Bitcoin requires enormous worldwide infrastructure.”45

In 2021, Wolfe Research studied how crypto and gold respond to shocks in market volatility and found that crypto indeed struggles in risk-off events, dropping materially after market volatility. This challenges the notion that crypto can play a gold-like diversifier role. Gold, on the other hand, offers a better hedge against equity market sell-offs, Wolfe concluded. Even if cryptocurrency is potentially the new favorite for inflation hedging, surpassing gold, it is far from being a safe haven asset like gold.46


In difficult times, critiques of cryptocurrencies like bitcoin take on more force. In 2021, before the big losses of this year, Brookings Institution economist Eswar Prasad offered biting criticism headlined “The Brutal Truth about Bitcoin.”47 Prasad questioned key aspects of the case for cryptocurrencies. He noted that the rise of Bitcoin nurtured “a darknet” of illegal payments in its early days, much as PayPal, with greater legality, enabled the rise of the early eBay. As bitcoin grew, it became “cumbersome, slow and expensive to use.” And increasingly, its much-vaunted anonymity broke down as law enforcement tracked and seized digital wallets of bitcoin in its efforts to combat ransomware.

Prasad continued: “While Bitcoin has failed in its stated objectives, it has become a speculative investment. This is puzzling. It has no intrinsic value and is not backed by anything. Bitcoin devotees will tell you that, like gold, its value comes from its scarcity …. But scarcity by itself can hardly be a source of value. Bitcoin investors seem to be relying on the greater fool theory — all you need to profit from an investment is to find someone willing to buy the asset at an even higher price.”

Hyun Song Shin, head of research at the BIS, offered a somewhat more balanced appraisal in a recent speech at the bank’s annual meeting.  He noted that the crypto sector “provides a glimpse of promising technological possibilities, but it cannot fulfill all the high-level goals of a digital monetary system. It suffers from inherent shortcomings in stability, efficiency, accountability and integrity that can only be partially addressed by regulation. Fundamentally, crypto and stablecoins lead to a fragmented and fragile monetary system. Importantly, these flaws derive from the underlying economics of incentives, not from technological constraints. And, no less significantly, these flaws would persist even if regulation and oversight were to address the financial instability problems and risk of loss implicit in crypto.”48

All this is not to say that cryptocurrencies and platforms like DeFi or stablecoins are about to disappear. Few financial instruments or technologies ever truly disappear, though they may go through periods of decline or consolidation, much like developments such as the internet, artificial intelligence or even financial instruments such as high-yield bonds. Crypto has, like the internet, undergone a dynamic, rapid and in many ways fascinating evolution. Like many such explosions of change, crypto has also suffered dramatic episodes of culling and reordering.

Will Bitcoin, Ether or hundreds of other coins and tokens survive? No one knows. What we do know is that the underlying digital technology has been remarkably fertile in offering new answers to old questions. The likeliest possibility is that blockchain technology will survive in some form or other.


Medy Kurniady is a Senior Analyst in the Directorate of Capital Market Enforcement at the Indonesia Financial Service Authority and worked as an Intern at WorldQuant as part of the IFC–Milken Institute Capital Markets Program. He holds a Bachelor of Accounting degree from University of Indonesia.

Awa Njie is a Senior Bank Examiner at the Central Bank of the Gambia and worked as an Intern at WorldQuant as part of the IFC–Milken Institute Capital Markets Program. She holds a MSC Banking and Finance degree from Coventry University in the UK.