Cryptocurrency investors have lost a combined $2 trillion since November, and the casualties of the ongoing crypto winter continue to mount.
The downturn was compounded by the collapse of the world’s second-largest cryptocurrency exchange, FTX, which went bankrupt last month, leading to accusations that its former chief executive was running a “Ponzi scheme” – something he denied.
Now, Mohamed El-Erian, dean of Queens College, University of Cambridge, is warning that a lack of risk management in the crypto space could be the canary in the coal mine, with wider economic ramifications.
“What if the irresponsible risk-taking that we’re seeing in cryptocurrencies is also happening elsewhere … and cryptocurrencies happen to be the most structurally vulnerable of those cases?” he asked new york times reporter Ezra Klein during an interview on Friday.
El-Erian believes that the dark days of cryptocurrencies do not yet pose a “systemic” risk to the financial system or the wider economy, but he says there are gloomy signs everywhere, including the near-collapse of the UK gilt market and emerging market The debt crisis in Sri Lanka and other places.
“My concern is…they’re just canaries,” he told new york timeFriday. “These are small fires, but the risk here is that these small fires start to spread and start to get bigger.”
El-Erian believes that the Fed’s near-zero interest rates and willingness to support the market during difficult economic times have given some investors a “perception that the market can only go up,” which has created an aggressive and dangerous risk appetite.
The economist, who was the chief executive of Pimco, said that after the 2008 financial crisis, the banking system was strictly regulated, but the risks in the entire financial system have not disappeared.
“It migrated. It moved from banks to non-banks,” he said. “And non-banks have less understanding of regulators, poor oversight, poor oversight.”
The BIS warned earlier this month that pension funds and other non-bank financial institutions owe around $25 trillion in debt that is largely “hidden” from regulators.
“This off-balance-sheet dollar debt poses special policy challenges because it is missed by standard debt statistics,” the BIS researchers wrote. “Therefore, in times of crisis, policies to restore the smooth flow of short-term dollars through the financial system are on the back burner.”
El-Erian said his biggest concern was that a “financial accident” caused by reckless behavior by non-banks would “spill into the real economy.”
“We saw in 2008 how bad the world of the banking system was going to be,” he said. “I don’t think it’s going to get that bad, but I’m concerned it’s another drag on high, sustained and inclusive growth. We desperately need high, sustained and inclusive growth.”
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