The latest research from the International Monetary Fund (IMF) suggests that cryptocurrencies are no longer on the outside of the financial system looking in, which ignites a new set of worries regarding financial stability.
The report of the IMF shed light on the current status of cryptocurrencies in the financial system. According to the findings, while cryptocurrencies are no longer isolated assets in the financial system, the increasing correlation with the stock market will decisively discredit the role of Bitcoin (BTC) and other cryptocurrencies as a hedge against inflation.
The IMF posted the findings in their blog, along with some emphasized emerging risks as the similarities between cryptocurrencies and financial markets continue to grow. It was highlighted that the result of this correlation “limits their perceived risk diversification benefits and raises the risk of contagion across financial markets,” according to Tobias Adrian, director of the IMF’s Monetary and Capital Markets Department, economist Tara Iyer, and Research deputy division chief Mahvash S. Qureshi.
It was stated in the article that “crypto assets such as Bitcoin have matured from an obscure asset class with few users to an integral part of the digital asset revolution,” and this development lists new risks that threaten financial stability.
While prior to the pandemic, neither Bitcoin (BTC) nor Ethereum (ETH) had an interconnectedness with major stock indexes, the article pointed out that risk diversification was made possible through cryptocurrencies, especially when it came to hedging the risk against other assets. Nonetheless, the situation changed after the early 2020 extraordinary central bank crisis responses where the growth of stocks and crypto went in tandem with the growth of the investors’ risk-seeking behavior.
The parallel rise and fall of the asset classes have been noted since the emergence of Covid-19, best portrayed by the growth from 0.01 to 0.36 in April 2020 of the correlation coefficient among the S&P 500 Index and Bitcoin (BTC), incurring a 3,600% rise.
The IMF experts posit that the stronger the correlation, the bigger risks for Bitcoin (BTC). This growing correlation between equity markets and crypto can pose risks that threaten financial market stability. According to the authors, “given their relatively high volatility and valuations, their increased co-movement could soon pose risks to financial stability especially in countries with widespread crypto adoption.”
Given these findings, the authors of the report recommended the establishment of a global framework for regulating cryptocurrencies, “to guide national regulation and supervision and mitigate the financial stability risks stemming from the crypto ecosystem.”
Similarly, Gita Gopinath, the chief economist of the IMF called for the same global framework, by claiming that the inconsistencies in some countries embracing crypto and others banning them altogether also pose a risk. Gopinath reasoned that the countries that ban cryptocurrencies would merely be powerless to offshore exchanges.
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