IMF Warns About Cryptocurrency’s Ability to Destabilize Markets

• The multilateral financier recommended to all countries regulate crypto assets according to their use.
• IMF experts warn that there is a dangerous threat between cryptocurrencies and stocks, which can spark a crisis.

The International Monetary Fund (IMF) recognized that Bitcoin and other cryptocurrencies can cause a domino effect and destabilize global financial markets, if their use is not regulated.

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.

During the pandemic crisis, some of the assets that grew the most were cryptocurrencies, due to the immense amount of cheap money that was released by central banks in the form of stimuli to prevent the recession from worsening.

Wall Street hit all-time highs in 2021, along with the rest of the world stocks that saw a strong recovery. Meanwhile, returns on digital assets are also skyrocketing to record levels.

So, the confluence of cryptocurrencies and stocks in the markets, caused both assets to correlate.

“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.

The experts explained that:

“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.“

Cryptocurrencies grew with financial stimuli

Since then, Bitcoin began to be compared to gold and silver and was called the “new digital gold”. Many investors have now incorporated digital assets into their investment portfolios to diversify them for higher returns or just to hedge against inflation.

At the beginning 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, 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.

On 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.

The fact is that all this implies a very high risk of a domino effect for the markets and also for investors. “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, Tether, 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.

The IMF Report warns that:

“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.”

Another finding of the IMF analysis is that this transmission of perceptions about these assets becomes more intense during turbulent phases of the markets.

“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

• Against this background, the International Monetary Fund is calling on all regular bodies in the world to adopt a comprehensive and coordinated global regulatory framework.
• In this way, countries can have common supervisory parameters that help mitigate growing risks to global financial stability.