IMF: Crypto is Syncing with Stocks, Posing ‘Risks to Financial Stability’
The International Monetary Fund (IMF) has raised concerns about the growing synchronization between cryptocurrencies and the stock market. It believes the current situation, together with the continued digital asset adoption, poses a threat to the stability of the global financial market.
Growing Correlation Between Crypto and Stocks
An IMF research shows that cryptocurrencies like Bitcoin and Ethereum have increased correlation with major stock indices since the pandemic. Before Covid-19, there was little to no correspondence between both asset classes.
The consensus was that the fringe nature of crypto made it an ideal asset class to diversify and hedge against swings in other asset classes. However, the response of central banks to the Covid outbreak has caused a shift in that assumption. Easier financial conditions, due to the stimulus in some countries, increased retail investors’ risk appetite significantly. This led to a sync in the price of cryptocurrency and US stocks.
The study states that Bitcoin returns moved in tandem with the S&P 500 (the benchmark stock index for the United States) since 2020. The correlation coefficient of their daily moves was only 0.01 between 2017-2019. It increased to 0.36 in 2020, with the assets moving more in lockstep, rising or falling together.
The findings also show a similar pattern in the relationship between crypto and equities in emerging markets hosted in the MSCI index.
The volatility correlation between Bitcoin, Ether, and the MSCI index has increased three to four-folds between the pre and post-pandemic periods. The increase is even more significant for Tether, absent at the US fact-finding hearing last month.
As seen in the chart above, the correlation for returns has also lurched upwards over time, with Bitcoin returns being more pronounced. The statistics show that the connection between Bitcoin, Ether, and US equity indices in the post-pandemic period is positive and similar.
In contrast, the correlation between Tether and all major equity indices has been more negligible but negative in 2020–21. This implies that USDT has been used as a risk diversification asset during this period.
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IMF Sounds The Alarm Against Crypto
The IMF, which has been critical of El-Salvador’s rising debt, has called for a global regulatory framework to mitigate the financial stability risks. It believes that the growing interconnectedness of the two asset classes allows shocks that can destabilize financial markets to be transmitted.
With digital assets no longer on the fringes due to increased adoption, their high volatility and co-movement pose significant risks. The IMF has called for a comprehensive and coordinated guide for national regulation and supervision to curtail this threat.
The proposed framework is expected to include laws targeted at the primary uses of crypto assets. Also, clear obligations for regulated financial institutions, in terms of their exposure and involvement with these assets, would be established.
Furthermore, the data gaps caused by anonymity in the digital assets industry and restricted worldwide standards must be quickly filled. This will help monitor and understand the rapid advancements in the crypto ecosystem and the risks they create.
The nascent nature of the crypto markets is another factor to consider. It can be argued that the cryptocurrency market may need more time to establish a concrete and sustainable premise for this correlation, instead of being driven mainly by low FED rates, which might increase soon.
Do you see the IMF regulating the crypto industry in light of the global financial market’s risks? Let us know in the comments below.