The International Monetary Fund warns of the ability of cryptocurrency to destabilize markets
- The multilateral funder recommended that all countries regulate crypto assets according to their use.
- International Monetary Fund experts warn that there is a serious threat between cryptocurrencies and stocks, which could lead to a crisis.
The International Monetary Fund (IMF) has recognized that cryptocurrencies and others can cause a domino effect and destabilize global financial markets, if their use is not regulated.
In a recent report, the Financial Authority’s analysts warned of the risks that exist in economies due to the volatility of cryptocurrencies, an element that could plague the stock market.
During the pandemic crisis, some of the top-grossing assets were cryptocurrencies, due to the huge amount of cheap money that central banks released in the form of stimuli to prevent the recession from getting worse.
Wall Street hit an all-time high in 2021, along with the rest of the global stocks that saw a strong recovery. Meanwhile, digital asset returns have also soared to record levels.
Therefore, the confluence of cryptocurrencies and stocks in the markets led to the correlation of both origins.
“The correlation of crypto assets with traditional holdings such as stocks has increased dramatically, limiting the advantages of perceived risk diversification and increasing the risk of contagion across financial markets,” wrote IMF economists Tobias Adrian, Tara Ayer and Mahfash S Qureshi.
Experts explained that:
Crypto assets such as Bitcoin and Ether showed little correlation with major stock indices. It was believed to help diversify risk and act as a hedge against fluctuations in other asset classes.
Cryptocurrencies have grown with financial catalysts
Since then, Bitcoin has been compared to gold and silver and has been dubbed the “new digital gold.” Many investors have now incorporated digital assets into their portfolios to diversify to get higher returns or just to hedge against inflation.
At the start of the pandemic, bitcoin was trading at around $5,000. Almost two years later, its price has increased eightfold. The popularization of the world’s largest cryptocurrency among small investors, especially millennials and Generation Z, had a lot to do with this.
IMF experts acknowledge that cryptocurrency’s relationship with stocks began with the “extraordinary responses to the central bank crisis in early 2020.”
“The prices of cryptocurrencies and US stocks alike rose amid soft global financial conditions and an increase in investors’ appetite for risk,” they said.
on the flip side
- “The stronger correlations indicate that bitcoin has been operating as a risky asset.” IMF analysts said.
- They added that “its relationship to stocks has turned into a higher level than the relationship between stocks and other assets such as gold, investment-grade bonds and major currencies.”
The truth is that all of this carries a very high risk of a domino effect for the markets as well as for the investors. Experts cautioned that “increasing correlation between crypto-equities increases the potential for investor sentiment ramifications among these asset classes.”
They argue in their analysis that they examined “the fallout from the dominant stablecoin, to global stock markets which has also increased during the pandemic” all of which “suggest that the spillover effects of bitcoin’s returns and volatility in stock markets, and vice versa, increased significantly in 2020-2021.” “.
According to the Financial Authority’s calculations, the recent volatility in BTC may explain about one-sixth of the volatility experienced by the S&P 500 during the pandemic and about one-tenth of the variance in stock returns.
The IMF report warns that:
“The sharp drop in bitcoin’s price could increase investor risk aversion and lead to lower investment in stock markets.” Therefore, “that feeling in one market is transmitted to the other in a counter-intuitive way.”
Another finding of the IMF analysis is that the transmission of perceptions about these assets becomes more intense during turbulent phases of the markets.
They conclude that “the spillover between the cryptocurrency and equity markets tends to increase during periods of financial market volatility – as occurred in the market turmoil in March 2020 – or during sharp fluctuations in bitcoin prices, as observed in early 2021.”
Why should you care
- Against this background, the IMF calls on all the ordinary bodies of the world to adopt a comprehensive and coordinated global regulatory framework.
- In this way, countries can have common supervisory standards that help mitigate rising risks to global financial stability.
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