This cryptocurrency winter may threaten the entire financial market.

As the cryptocurrency market enters another winter, unlike previous cyclical fluctuations, this downturn—driven by the deep entanglement of digital assets with mainstream financial systems—is posing an unprecedented threat to the broader financial system. The core risk does not lie in simple price speculation, but rather in mechanism-level changes that aim not only to build an alternative financial system but also to permeate traditional markets.

Bitcoin has fallen 30% in less than two months, erasing all gains made this year, while losses in other crypto assets are even more severe. Alarming is that this crash occurred under what is considered the most favorable regulatory environment in history.

Instead of using loose policies to build a robust system, the market has fostered memecoins on the stock exchange, nearly unlimited leverage on trading platforms, and frenzied prediction markets surrounding political events like government shutdowns. Indeed, just this week, an ETF tracking Dogecoin was also listed on the New York Stock Exchange.

The most noteworthy and potentially riskiest aspect of the current crisis is the rise of stablecoins. With the so-called "Genius Act" providing credibility to the industry, stablecoins are rapidly expanding and being adopted by enterprises beyond the crypto sector.

However, should a trust crisis hit this seemingly "stable" asset class, the resulting wave of sell-offs would directly impact U.S. Treasuries and money markets, potentially repeating systemic risks similar to the 2008 financial crisis or the 2023 banking turmoil.

Lee Reiners, researcher at the Center for Financial Economics at Duke University and former Federal Reserve official, warns: Just like money market funds and the repo market, stablecoins inevitably face run risk. If investors panic and sell, issuers would be forced to liquidate traditional financial assets held as reserves, transmitting the crypto market’s chill across the global financial system.

Deleveraging and Discount Cycles

The current wave of sell-offs began with over-leverage and a bursting valuation bubble. At the center of this crash is the Singapore-based crypto exchange Hyperliquid. Despite having only 11 employees, the exchange handles $13 billion in daily trading volume and offers astonishing high-leverage services. In October, the platform saw liquidations amounting to $10 billion, with shockwaves rapidly affecting the entire market.

In the traditional stock market, publicly listed companies holding large amounts of crypto assets ("crypto treasury stocks") have become the biggest losers. Previously, market frenzy drove their share prices to trade at premiums over their crypto holdings, with investors believing it reasonable to pay $2 for each $1 of crypto asset held. This prompted companies to issue shares or take on debt to buy more crypto, further pushing up prices.

Now, this logic is painfully reversing. These companies' share prices have dropped below the value of their crypto holdings, trading at discounts. Logically, these firms now lean toward selling crypto to buy back their own stock. This selling further depresses crypto prices, creating a self-reinforcing downward spiral.

Stablecoin Expansion and Entry of Traditional Giants

Amid market turmoil, the stablecoin sector is instead experiencing expansion, which actually increases potential risk exposure. As the crypto assets closest to an alternative financial system, stablecoins promise zero volatility by pegging to the U.S. dollar, and have gained a legitimacy halo under the new "Genius Act" regulatory framework.

This environment is attracting traditional business giants. Swedish "buy now, pay later" service Klarna announced this week that it would launch a stablecoin called KlarnaUSD next year. Previously, payment company Western Union and cloud service provider Cloudflare had also entered the field. Although the market remains dominated by Circle and Tether—whose combined market value is about $250 billion—the entry of new players like Klarna, especially with their overseas applications, is tightening the link between stablecoins and global commercial activities.

In countries like Argentina and Turkey, where currencies are unstable or capital controls are imposed, stablecoins have become the easiest way to acquire and transfer dollars. Yet such widespread application means that once a crisis occurs, its transmission channels will be more diverse and globalized.

Redemption Crisis and Systemic Risk

Stablecoins typically maintain their 1:1 dollar peg by holding safe assets such as short-term treasuries, bank deposits, and money market funds. Ironically, these crypto assets rely on the traditional financial instruments they tend to disdain in order to stay stable. History shows that promises of stability are easier made than fulfilled.

This month, a small stablecoin operated by Stream Finance promising about 18% yield collapsed. The company went under after losing $93 million, with about $200 million market value wiped out.

This case reveals the dark side behind stablecoin promises: bank runs. For investors, losing venture capital is one thing; losing savings is another—and the latter can easily trigger panic withdrawals.

Even giant industry players are not immune. When Silicon Valley Bank (SVB) collapsed in 2023, Circle, a main U.S. stablecoin issuer, faced a run because it had $3.3 billion deposited at SVB; its stablecoin price once fell to $0.88. Circle survived after regulators promised full repayment of SVB deposits, but this exposed the fragile connection between stablecoins and the banking system.

Lee Reiners points out that SVB's failure stemmed from the devaluation of its "ultra-safe" treasuries as rates rose. This is the same transmission mechanism currently haunting markets. If investors dump stablecoins on a large scale, issuers will be forced to sell underlying reserve assets such as treasuries.

Given volatility in the treasury market has triggered many past crises, stablecoins may become a new and unpredictable risk source in the financial system. Just as the tiny crack in money market funds in 2008 led to a darkest moment, people often realize the risks are present only after crisis has erupted.

Risk Warning and DisclaimerMarkets are risky; investments require caution. This article does not constitute personal investment advice, nor does it take into account any individual user’s specific investment goals, financial situation, or needs. Users should consider whether any opinion, viewpoint, or conclusion contained herein fits their particular circumstances. Investing based on this is at your own risk.