For a decade, Bitcoin (BTC) and other cryptocurrencies were treated as hedges against other types of assets, such as stocks. But after COVID, crypto asset prices are increasingly reflecting equities.
No longer a hedge against equities
According to the economists, more people should add risky assets to their wallets. Tobias, Iyer and Qureshi therefore conclude that cryptocurrencies are quickly gaining ground. They say the following about this:
“Our analysis suggests that crypto assets are no longer on the fringes of the financial system.”
That could be a sign of trouble ahead, three International Monetary Fund (IMF) officials say. The UN institution is known for providing conditional loans to member countries.
“The increased and extensive co-movement and spillovers between crypto and equity markets indicate an increasing interconnectedness between the two asset classes. This allows for the transfer of ‘shocks’ that can destabilize financial markets.”
Economists Adrian Tobias, Tara Iyer, and Mahvash S. Qureshi wrote on the IMF’s blog. They cite new research from Iyer showing there is a “risk of contagion across financial markets.” The trio therefore advocate a global regulatory framework to mitigate threats to financial stability.
#Crypto and stocks are moving much more in sync and our latest research shows how this may be a risk to the stability of financial markets. See our latest #IMFblog for more. https://t.co/B5h2x4FPID pic.twitter.com/IvT6QwOe0e
— IMF (@IMFNews) January 11, 2022
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A recent report from crypto asset data firm Kaiko linked the correlation coefficient between Bitcoin’s price and the S&P 500 stock index at 0.61. The correlation between Bitcoin and the Nasdaq was 0.58. Correlation coefficients range from -1 to 1. The closer to 1, the more they move toward each other. The closer to -1, the more they diverge.
The IMF authors note that the correlation doesn’t just extend to US stock markets. The developing economies are also experiencing growth in correlation. They estimate the correlation between Bitcoin and the MSCI emerging markets index at 0.34 in 2020-21. This is a 17x jump from before.
While stock markets are traditionally regulated by their host countries, many nations are still figuring out how to handle crypto assets.
The SEC oversees US stock markets and ensures the diversity of crypto assets and crypto platforms. FFTs, DeFi governance tokens, and stablecoins all have different utilities and ensure the industry lacks a single regulatory body. The distribution is therefore inconvenient and sometimes it is unclear who should guard whom.
Tobias, Iyer and Qureshi argue that any regulatory framework should include requirements for banks about their exposure to crypto assets. It must also be stated how banks can deal with such assets. If not, they warn, the increased correlation between crypto and equities “could quickly pose risks to financial stability. Particularly in countries with widespread adoption of crypto.”