Crypto assets have matured to an integral part of the digital asset era.
However, lately, they’ve been raising financial stability concerns.
Their market value rose to nearly $3 trillion in November 2021, from $620 billion in 2017. Despite their high volatility, these digital assets have been soaring in popularity among institutional and retail investors alike.
According to a new IMF research, the greater adoption of crypto-assets has increased their correlation with traditional holdings like stocks. The aforementioned development limits their perceived risk diversification benefits and spikes the risk of contagion across monetary markets.
Before the pandemic, crypto-assets like Ether and Bitcoin showed little correlation with stock indices. Experts believed they acted as a hedge against common swings in other asset classes. But, after the extraordinary central bank crisis in 2020, crypto prices and US stocks surged amid greater investor risk appetite and easy global financial conditions.
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Stronger correlations signify the fact that Bitcoins have been acting as a risky asset. Its dependence on stocks has soared than that between stocks and other assets such as investment-grade bonds, gold, and major currencies.
Increased crypto-stocks correlation surges the possibility of spillovers of investor sentiment stuck between those asset classes. As per IMF, volatility to stock markets and spillovers from Bitcoin returns, and vice versa, have grown significantly in 2020–21.
A sharp decline in Bitcoin prices can surge investor risk aversion, leading to a fall in investments in stock markets. As per experts, sentiment in one market is transferred to the other in a nontrivial way.
IMF’s analysis shows that spillovers between equity markets and crypto tend to increase in times of financial market volatility, such as in the March 2020 market turmoil or during swings in Bitcoin prices, as seen in early 2021.
The IMF suggests that crypto assets aren’t on the fringe of the financial system anymore.