Cryptocurrencies are no longer an unknown asset class within the financial ecosystem, but their growing correlation with the stock market undermines the “investment hedge” role of Bitcoin (BTC) and other cryptocurrencies, according to a new study of the International Monetary Fund (IMF).
A blog article that accompanies the study highlights the new risks associated with the growing interconnection between virtual assets and financial markets. Written by the Director of the IMF’s Monetary and Capital Markets Department, Tobias Adrian, as well as by the economist Tara Iyer and the Deputy Chief of the Research Division, Mahvash S. Qureshi, the article affirms that the growing correlation between crypto assets and stocks “limits their perceived benefits of risk diversification and increases the risk of contagion in financial markets”.
“Crypto assets, like Bitcoin, have gone from being an unknown asset class with few users to becoming an integral part of the digital asset revolution“, reads the article, adding that this transition is accompanied by concerns about financial stability.
Since BTC and Ether (ETH) rarely correlated with major stock indices before the pandemic, the authors agreed that crypto assets helped diversify risk for investors by acting as a hedge against swings in other asset classes. “But this changed after the extraordinary responses of central banks to the crisis in early 2020,” the article reads, adding that cryptocurrencies and equities rose as investors’ appetite for risk increased. .
The correlation coefficient between the price of Bitcoin and the S&P 500 index has shot up 3,600%, going from 0.01 to 0.36 after April 2020. This means that the two asset classes have risen and fallen more similarly since the coronavirus pandemic.
With Tighter Correlation Comes Higher Risks for Bitcoin, according to IMF experts. The growing interconnection between the cryptocurrency and equity markets would allow the transmission of shocks that can destabilize financial markets. Noting that crypto assets are no longer on the fringes of the financial system, the authors said:
“Given their volatility and relatively high valuations, their growing joint movement could soon pose risks to financial stability, especially in countries with wide adoption of crypto assets.”
The experts they further called for a coordinated global regulatory framework “to guide national regulation and supervision and mitigate financial stability risks stemming from the cryptocurrency ecosystem.”“.
Last month, IMF Chief Economist Gita Gopinath made a similar call for a global policy regarding cryptocurrencies. He argued that if countries ban cryptocurrencies, they will have no control over foreign exchanges that are not subject to their country’s regulations.
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The IMF Says Bitcoin Has Matured To Become “An Integral Part Of The Digital Asset Revolution”