• Multilateral financial institutions recommended that all countries should regulate crypto assets according their usage.
• IMF experts warned that cryptocurrency and stock trading pose a serious threat, which could cause a crisis.

International Monetary Fund (IMF), which recognized that cryptocurrencies like Bitcoin can have a domino effect on global financial markets and cause instability if not controlled, acknowledged this.

In a recent report, the financial body’s analysts warned about the risks present in the economies due to the volatility of cryptocurrencies, an element that can infect the stock market.

Due to central banks’ massive release of stimulus money to stop the recession from getting worsening, cryptocurrencies were some of the fastest growing assets during the crisis.

Wall Street and the other world stocks saw strong recovery in 2021. Wall Street reached all-time heights. Digital assets’ returns are also on the rise, reaching record highs.

Both assets became compatible due to the convergence of stocks and cryptocurrencies.

“The correlation of crypto assets with traditional holdings like stocks has increased significantly, which limits their perceived risk diversification benefits and raises the risk of contagion across financial markets,” wrote IMF economists Tobias Adrian, Tara Iyer and Mahvash S. Qureshi.

According to experts,

“Crypto assets such as Bitcoin and Ether showed little correlation with major stock indices. They were thought to help diversify risk and act as a hedge against swings in other asset classes.“

With financial stimulus, cryptocurrencies have grown.

Since then, Bitcoin began to be compared to gold and silver and was called the “new digital gold”. To diversify their portfolios and hedge against inflation, many investors now incorporate digital assets.

Bitcoin’s price was $ 5,000 at the start of the pandemic. Its price has risen eightfold in the past two years. The popularization of the world’s largest cryptocurrency among small investors, particularly millennials and generation Z, had a lot to do with this.

IMF experts acknowledged that this crypto-equity correlation began with “the extraordinary central bank crisis responses of early 2020.”

“Crypto prices and US stocks both surged amid easy global financial conditions and greater investor risk appetite,” they said.

The Flipside

• “Stronger correlations suggest that Bitcoin has been acting as a risky asset.” said IMF analysts.
• “Its correlation with stocks has turned higher than that between stocks and other assets such as gold, investment grade bonds, and major currencies,” they added.

All of this carries a high level risk for both investors and the market. “Increased crypto-stocks correlation raises the possibility of spillovers of investor sentiment between those asset classes,” the experts warned.

They argued that in their analysis they examined “Spillovers from the dominant stablecoin, , to global equity markets also increased during the pandemic” All of which “suggests that the spill-over effects of bitcoin returns and volatility on the stock markets, and vice versa, have increased significantly in 2020-2021.”

According to the financial body’s calculations, the recent volatility of the BTC may explain about a sixth of the volatility that the S&P 500 had during the pandemic and about a tenth of the variation in the returns of stocks.

According to the IMF Report,:

“A sharp decline in Bitcoin prices can increase investor risk aversion and lead to a fall in investment in stock markets”. So “that sentiment in one market is transmitted to the other in a nontrivial way.”

The IMF analysis also revealed that perceptions of these assets are transmitted more strongly during market turmoil.

“That spillovers between crypto and equity markets tend to increase in episodes of financial market volatility—such as in the March 2020 market turmoil—or during sharp swings in Bitcoin prices, as observed in early 2021.”, they concluded.

Why you should care

• The International Monetary Fund calls on regular international bodies to create a global, coordinated regulatory system.
• This will allow countries to share common financial supervision that helps reduce growing risk of instability.

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