Just about everyone agrees that the U.S. government defaulting on its debt obligations in June would be an economic catastrophe of the highest order. For cryptocurrencies, the impact of a debt default would be far more consequential than the current banking crisis.
And, yet, a number of prominent voices are actually suggesting that crypto might soar in the wake of a U.S. government default. Standard Chartered Bank, for example, is now suggesting that Bitcoin (CRYPTO: BTC) might soar by 70% as it becomes a safe-haven asset. But just how realistic is that prediction? Below are three possible scenarios for what might happen to crypto.
Worst-case scenario
Let's start off with a worst-case scenario, so we can understand how truly catastrophic a debt default would be. There would be an immediate backlash against every U.S. asset, including the U.S. dollar. And, as Treasury Secretary Janet Yellen has warned, there would likely be mass layoffs, payment failures across the economy, and a cratering of U.S. credit markets. Most likely, investors would immediately dump holdings of any risky U.S. cryptocurrency stocks, such as crypto mining stocks.
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But what about cryptocurrencies themselves? Unlike in the current banking crisis, investors would not be able to pull money out of one place (i.e., the banking sector) and put it into another (i.e., the crypto sector). Debt instruments are not deposits. When a government defaults on its debt, all that's left is a worthless piece of paper backed by the "full faith and credit" of whoever issued it.
Thus, I don't see how there would be a massive influx of funds into crypto. Going forward, institutional investors might eventually ramp up their holdings of crypto as a further hedge against financial catastrophe, but there wouldn't be a sudden surge. More likely, investors would simply put their funds into the ultimate safe-haven asset: physical gold.
Medium-case scenario
A medium-case scenario is that the U.S. government "technically" defaults on its nearly $32 trillion in debt on June 1, but quickly finds some way to restructure the debt so it can be repaid. This would set into motion the ultimate "too big to fail" scenario -- once investors and lenders get a whiff of the chaos that might ensue after a debt default, they would surely work to provide some sort of liquidity backstop or short-term stabilization fund, just as we saw with the financial crisis of 2008.
But the damage would still be nearly irrevocable. Yes, the U.S. government would be able to issue new debt in the future, but at dramatically higher interest rates. Lenders that were part of the "too big to fail" coalition would probably also demand immediate austerity steps from the U.S. government, such as a commitment to scale back spending.
But that would be absolutely soul-crushing for the U.S. economy. And, again, I don't see any way that would really benefit crypto. Investors would likely turn to precious metals such as gold and silver, commodities, and other assets that have tangible value, such as real estate. Since crypto does not have any tangible value, I don't see how it would become a desirable investment in this new environment.
In fact, in a rising rate environment, crypto would become relatively less attractive than debt assets paying very high interest rates. This is a well-known phenomenon within the crypto sector that we've seen play out this year. Higher interest rates are bad for crypto, which is why Federal Reserve rate hikes are such a concern.
Best-case scenario
Finally, there's a best-case scenario. But it's only a "best" case on a relative basis. It would still be absolutely awful. The U.S. dollar would likely lose its current standing as the world's reserve currency, and it's almost impossible that Bitcoin would be able to fill the void this year. Most likely, we're talking about the Chinese yuan becoming the world's new reserve currency.
Where I do agree with Standard Chartered Bank is that there will be a set of winners within the crypto world and a set of losers. It's too simplistic to say all cryptos will go up, or all cryptos will go down. According to Standard Chartered Bank, a U.S. debt default would make a "long Bitcoin, short Ethereum" strategy optimal, given Bitcoin's much greater adoption as a form of payment and a store of value. But other cryptos -- as long as they are not linked to the U.S. economy -- might also get a bump in value.
At the end of the day...
Nobody would really benefit from a U.S. debt default. Thinking that a U.S. debt default is "winnable" is similar to thinking that a thermonuclear war carried out with tactical nukes is "winnable."
So let's hope that U.S. politicians do the one thing that they are uniquely good at -- kicking the can down the road for someone else to deal with later. After a lot of last-minute political posturing and midnight sessions in Washington, Congressional leaders will likely emerge with an increase to the debt ceiling, freeing them up to continue spending until next year.
