What happened
Shares of crypto-focused stocks Block (SQ -1.97%), Coinbase (COIN 2.01%), and Silvergate Capital (SI -2.44%) were down big again on Tuesday, with the stocks down 8.7%, 8.6%, and 10.9%, respectively, as of 1:30 p.m. ET.
Although these three stocks are not cryptocurrencies in and of themselves, each is related to the health of the cryptocurrency market in some way. Yet with the current stock market sell-off, investors are fleeing newer and flashier kinds of assets like cryptocurrencies for more safe-haven stocks and assets. It also didn't help that the European Central Bank issued a warning over cryptocurrencies today on top of a down day for the markets.
So what
Today, the European Central Bank (ECB) issued its biannual financial stability report, which included the warning that "Systemic risk increases in line with the level of interconnectedness between crypto-assets and the traditional financial sector." It doesn't appear that the ECB is warning about a current financial crisis due to crypto; rather, it seems to be saying that if cryptocurrencies continue on their growth path and become more interconnected with the financial system, significant risks could appear.
Still, Bitcoin (BTC -1.53%), the leading cryptocurrency, was only down some 3.3% today. Yet these crypto-related stocks were down even more. This might be due to the fact that the ECB is targeting companies -- like these three -- that connect crypto to the "traditional" financial system.
The underperformance could also be due to last night's earnings pre-announcement from social media company Snap (SNAP 6.70%). While you may not think Snap has anything to do with these companies, the pre-announcement seemed to confirm investors' worst fears concerning the digital ad market. Many investors are extrapolating weak advertising sales to the health of the overall economy. An economic downturn poses additional risks for companies that partake in lending -- also a key activity for these three stocks.
Since Block is both a small-business payments platform, lender, and consumer finance ecosystem, its results will be sensitive to the overall economy. Block also recently acquired Afterpay, a "buy now, pay later" platform that could see increased delinquencies if the economy falters. And Block also held about $365 million worth of Bitcoin on its balance sheet as of March 31.
Meanwhile, Coinbase has gotten pummeled as the leading cryptocurrency exchange. Since its revenues are based on commissions that are a percentage of its clients' crypto holdings, when cryptocurrencies fall, so do the prospective profits of Coinbase. Additionally, Coinbase lends against crypto assets, so that is a risk as well.
Finally, Silvergate Capital has become a vendor of choice for crypto-related businesses thanks to its proprietary Silvergate Exchange Network (SEN), which can clear and settle transactions instantly -- a highly desirable trait for cryptocurrencies that trade 24/7. Silvergate has also lent money to crypto-focused businesses such as MicroStrategy (MSTR 1.69%). In March, Silvergate lent MicroStrategy $205 million, which was used to buy more Bitcoin. Overall, Silvergate has over $1 billion of commitments related to its SEN Leverage program, which lends against clients' Bitcoin holdings as of the end of last quarter.
Image source: Getty Images.
Now what
The growth of cryptocurrencies, and their current bust, reminds me of the dot com bust in the early 2000s. While some companies would be survivors and go on to make fortunes for investors, there was quite a big hangover after the bubble burst, and many didn't survive. That's why investors should be very careful about their crypto investments and allocations as a percentage of their overall wealth.
Additionally, the same goes for crypto-focused stocks. As we saw today, they have the ability to fall very hard if their businesses are too interconnected with cryptocurrencies. Meanwhile, with macroeconomic risks on the rise, investors should also be careful of any financial stock that lends money -- crypto-related or not.
