What’s Crypto Contagion, and How Does it Affect the Market?

Crypto contagion can be described as a negative event in the crypto market that prompts a chain reaction, leading to a wider market downturn. There are numerous factors that can cause crypto contagion. They include:

Regulatory crackdowns: If a certain government imposes tough rules on a specific crypto asset, it could cause its value to decline and may subsequently impact other tokens since investors will start to worry that such policies could be adopted on the cryptocurrencies they are holding.

Exploits: Hacking incidents can cause investors to lose faith in crypto markets, prompting them to sell off their bags to avoid losing their funds to attackers.

How Does Crypto Contagion Affect the Market?

Crypto contagion effects are divided into two: micro-level and Macro-level effects.

Micro-level effects focus on crypto businesses and retail investors. For example, a loss of faith in a particular crypto asset can fuel a sell-off, causing its price to drop sharply. That will lead to individual investors of that asset suffering financial losses. It could also impact the revenues of crypto firms, such as those involved in mining and exchanges.

On the other hand, macro-level effects extend beyond the crypto space, impacting other industries and the stability of the global financial system.

With the increased adoption of cryptocurrencies in various industries, a decline in investor confidence in these assets can negatively impact companies using crypto. Also, it could cause the global financial system, which has in some way integrated crypto, to be unstable.

Can Stablecoin Depegging Cause Crypto Contagion?

Investors may lose faith in the stablecoin market if one stablecoin starts trading below its expected price. They will begin to worry about other stablecoins’ stability and may be prompted to sell if not convinced.

Further, if investors abandon stablecoins, it would slow down the adoption of cryptocurrencies, considering that many new crypto users prefer to store their funds in stablecoins, shielding them from market volatility.

Crypto Contagion Effect Vs. Crypto Ripple Effect: What’s the Difference?

Both the crypto ripple effect and the crypto contagion effect imply the spread of changes across the crypto market. But the major difference between the two is that the ripple effect can be negative or positive, while the contagion effect usually suggests a negative spread of panic and fear, causing widespread sell-offs and price declines.

How Can Stakeholders Protect Themselves From Crypto Contagion?

By diversifying portfolios: To reduce exposure to crypto contagion, it is wise that investors purchase crypto along with other assets like bonds and stocks.

Crypto firms can adopt effective risk management practices: Businesses in the crypto industry can protect themselves from contagion by regularly conducting stress testing. This type of testing involves examining a system’s performance under adverse conditions to identify and mitigate potential risks.

Stay informed: By being aware of what’s currently happening in the market, investors are able to take necessary action to shield themselves against the negative effects of crypto contagion.

In addition, it is advisable for investors to perform due diligence before investing in any crypto asset. And after injecting funds into the crypto market, they should apply risk management tactics like placing stop-loss orders to avoid suffering severe financial losses in case of contagion.

Banks should adhere to strict KYC and AML policies: Financial institutions can protect themselves from the effects of crypto contagion by adopting strict anti-money laundering and know-your-customer policies to restrict illegal activities related to crypto assets.