The International Monetary Fund (IMF) has stated that crypto’s increasing correlation with equity markets will pose new risks to financial stability.
The IMF disclosed this in a blog post titled, ‘Crypto Prices Move More in Sync With Stocks, Posing New Risks’. Before the pandemic, crypto-assets like Bitcoin and Ether had a minimal association with major stock indices, according to the report. They were considered to help diversify risk and function as a hedge against asset class volatility.
However, after the dramatic central bank crisis responses of early 2020, this role altered. Cryptocurrency prices and stock prices in the United States have both risen as a result of easy global financial conditions and increased investor risk appetite.
What the report is saying
The Fund said that the increased and sizeable co-movement and spillovers between crypto and equity markets indicate a growing interconnectedness between the two asset classes that permits the transmission of shocks that can destabilize financial markets.
The correlation of crypto assets with traditional holdings like equities has increased dramatically as usage has grown, limiting their claimed risk diversification benefits and raising the potential of financial market contagion, according to new IMF research.
The report shows that the correlation between the stock market and cryptocurrency has increased as it states that, “Bitcoin did not move in a particular direction with the S&P 500, the benchmark stock index for the United States, in 2017–19. The correlation coefficient of their daily moves was just 0.01, but that measure jumped to 0.36 for 2020–21 as the assets moved more in lockstep, rising together or falling together.”
“Stronger correlations suggest that Bitcoin has been acting as a risky asset. Its correlation with stocks has turned higher than that between stocks and other assets such as gold, investment grade bonds, and major currencies, pointing to limited risk diversification benefits in contrast to what was initially perceived,” the report added
The IMF stated that given their relatively high volatility and valuations, their increased co-movement could soon pose risks to financial stability especially in countries with widespread crypto adoption.
The IMF advised it is time to adopt a comprehensive, coordinated global regulatory framework to guide national regulation and supervision and mitigate the financial stability risks stemming from the crypto ecosystem. The Fund added that to monitor and understand the rapid developments in the crypto ecosystem and the risks they create, data gaps created by the anonymity of such assets and limited global standards must be swiftly filled.