The tighter ties between cryptocurrencies and stocks raise ‘the risk of contagion across financial markets,’ the IMF says.
Many advocates of bitcoin and other cryptocurrencies have said they can serve as hedges against declines in other financial assets, such as stocks, reducing risk for investors.
The International Monetary Fund questions that assessment.
Amid the expansion of digital currencies, their “correlation with traditional holdings like stocks has increased significantly, which limits their perceived risk diversification benefits and raises the risk of contagion across financial markets,” International Monetary Fund officials wrote on the group’s blog, citing new IMF research.
The IMF, with 190 countries as members, is tasked with maintaining monetary cooperation, facilitating international trade, and more.
Before the Covid pandemic, digital currencies showed little correlation with stocks. But afterward, “crypto prices and U.S. stocks both surged amid easy global financial conditions and greater investor risk appetite,” the blog said.
In 2017-19, bitcoin and the S&P 500 index had just a 0.01 correlation, according to the IMF research.
But that rose to 0.36 for 2020-21. The correlation scale spans from zero (no correlation) to 1 (total correlation).
So far this year, the S&P 500 has slid 1.7%, while bitcoin has dropped 10.4%. It recently traded at $42,512, down 3%.
“Stronger correlations suggest that bitcoin has been acting as a risky asset,” the IMF blog said.
“Its correlation with stocks has turned higher than that between stocks and other assets such as gold, investment grade bonds, and major currencies, pointing to limited risk diversification benefits in contrast to what was initially perceived.”
The implications are worrisome, the IMF officials said. “Increased crypto-stocks correlation raises the possibility of spillovers of investor sentiment between those asset classes. … A sharp decline in bitcoin prices can increase investor risk aversion and lead to a fall in investment in stock markets.”
