New research from the International Monetary Fund warns that the increased correlation between Bitcoin and equities means cryptocurrencies may no longer be considered a fringe asset class and could pose financial stability risks due to their extreme price volatility.
The IMF says crypto’s correlation with stocks has turned higher than the correlation between stocks and other assets such as gold, investment-grade bonds, and major currencies, which indicates limited risk diversification benefits.
“Although initially considered a fringe asset class, [cryptocurrencies’] increased adoption across countries—in emerging markets, in particular—amid bouts of extreme price volatility has raised concerns about their potential financial stability implications,” the IMF said in a recent report.
The financial institution said the aim of its research was to examine the extent to which crypto assets have moved to the mainstream by estimating the potential for spillovers between cryptocurrencies and equity markets in the US, and in emerging markets using daily data on price volatility and returns.
“The analysis suggests that crypto and equity markets have become increasingly interconnected across economies over time,” said the report, which found that spillovers from price volatility of Bitcoin to the S&P 500 and MSCI emerging markets indexes have increased by approximately 12 to 16 percentage points since the COVID-19 pandemic started. And spillovers from Tether, which, according to the IMF, is the most traded stablecoin, to the indexes have also increased by about 4 to 6 percentage points.
The IMF said its findings suggest that the interconnectedness between crypto and equity markets “increased notably” between 2017 and 2021. For example, it said that compared with pre-pandemic years, the correlation between Bitcoin price volatility and S&P 500 index volatility has increased by more than four times, while Bitcoin’s contribution to the variation in the S&P 500 index volatility is estimated to have increased by about 16 percentage points during the post-pandemic period.
The research also saw a similar pattern for returns, with a significant increase in the correlation between Bitcoin and S&P 500 returns, as well as in the spillovers from Bitcoin returns to S&P 500 returns. The IMF said Bitcoin and Tether combined account for approximately 19% to 23% of the variation in the volatility of major global equity indexes, and about 12% to 17% of the variation in their returns in the post-pandemic period.
“In absolute terms, spillovers from Bitcoin to global equity markets are significant, explaining about 14% to 18% of the variation in equity price volatility and 8% to 10% of the variation in equity returns,” the IMF said. “These findings suggest that close monitoring of crypto asset markets and the adoption of appropriate regulatory policies are warranted to mitigate potential financial stability risks.”
The IMF warned that although the risks posed by crypto assets were deemed minimal until just a few years ago because their markets were so small then, their widespread and rapid adoption could pose financial stability risks due to their highly volatile prices, the rising use of leverage in their trading, and financial institutions’ direct and indirect exposures to crypto assets.
“Because of the relatively unregulated nature of the crypto ecosystem, any significant disruption to financial conditions driven by crypto price volatility could potentially be largely outside the control of central banks and regulatory authorities,” the IMF said in its report. “Regulators and supervisors need to closely monitor action in the crypto markets and the exposure of financial institutions to these assets, and design appropriate regulatory policies to mitigate systemic risks emanating from crypto price spillovers.”