Crypto’s co-movement with stocks could cause financial instability

The monetary authority proposes a global regulatory framework to alleviate financial stability risks posed by cryptocurrencies and their emerging adoption

In a blog post published On Tuesday, the International Monetary Fund (IMF) wrote that as crypto markets grow, there is an equivalent increase in the correlation between cryptocurrencies and financial markets.

The coronavirus pandemic redefined correlations in the investment landscape

Before COVID-19, the IMF explained, there was little relationship between crypto-assets like Bitcoin and stocks. As such, they were considered good options as a hedge against inflation for investors.

Over time, however, the pandemic pushed financial systems to the extreme, prompting the central bank to enact policies to ease tension. Subsequently, both cryptocurrency prices and the US stock market rose due to the conducive financial environment and increased risk appetite from investors.

As an example of the impact of bank responses, the correlation coefficient between Bitcoin returns and the S&P 500 soared to 0.36 in 2020-2021. This figure was unchanged at 0.01 between 2017 and 2019.

“For example, Bitcoin’s returns 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 its daily movements was only 0.01, But that measure jumped to 0.36 for 2020-21 as assets moved more in unison, rising together or falling together. “ read in the post.

The IMF noted that similar correlation behavior had been observed in the stock market and stable coins.

The monetary body explained that the spillovers between crypto markets and equity markets were mainly due to instances of market volatility or strong swings in the price of Bitcoin. In effect, he concluded that Bitcoin has been acting as a risk asset, observing that its co-movement with stocks had outpaced that of stocks and alternative assets like gold.

Regulations to curb systemic threats

The post also targeted a proposed framework posted above which provides guidelines on how global cryptocurrency regulations could be implemented. The proposal recommended, among other things, that crypto service providers should seek regulatory approval from relevant bodies to level the playing field.

The IMF also indicated that such a framework would be critical in addressing financial stability risks emerging from the crypto scene, with the adoption of mainstream crypto on the rise. Furthermore, he advised that regulations should be formulated around the main crypto use cases, how financial institutions relate to crypto-assets, and also establish monitoring schemes for the crypto ecosystem.

However, the organization insisted that as it strives to implement new regulations, care must be taken to ensure that innovation in the sector does not stifle.

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