IMF calls for global crypto regulation
Correlation between crypto and stock market
Financial stability threatened
IMF warns of risks of crypto trading
Just recently, the International Monetary Fund (IMF) warned of the risks associated with cryptocurrency trading. For example, the organization belonging to the United Nations recently criticized the fact that the supposedly prevailing anonymity in decentralized trading leads to incomplete data and thus there is a risk that the digital assets will be used for money laundering or to finance terrorism. To remedy this, the IMF called for comprehensive regulation of the crypto business on a global scale. “Time is of the essence, and action must be decisive, rapid and well-coordinated around the world to reap the benefits while also addressing the vulnerabilities,” the organization said, according to CNBC.
Cryptocurrencies on the rise
In a blog entry, the IMF once again expressed its concerns about digital currencies. Bitcoin & Co. have meanwhile blossomed from an “obscure asset class with few users” into an integral part of digital commerce, which is also reflected in the fact that the market value of all cybercoins has risen from 620 billion US dollars in 2017 to almost 3 trillion The US dollar appreciated in November, the institution said. On the crypto platform “CoinMarketCap”, the global market capitalization of all cryptocurrencies was recently 1.97 trillion US dollars (as of January 19, 2022). “Crypto assets are no longer on the fringes of the financial system,” IMF members Tobias Adrian, Tara Iyer and Mahvash S. Qureshi explain in the blog post. The authors of the article explain the strong increase in the crypto market value by the fact that the trend has reached both retail and institutional investors – despite the high volatility that trading in crypto assets brings with it. While cryptocurrencies were still considered a modern alternative to stock trading in the past, alternative investments are increasingly approaching the traditional financial market as they become more suitable for the masses, according to a study by the organization.
Connection between crypto market and stock trading
As Adrian, Iyer and Qureshi write in their article, a correlation can be seen between cryptocurrencies and stocks, for example, which weakens the desired risk diversification through both asset classes. However, this connection has only been apparent since the beginning of the pandemic. “Before the pandemic, cryptocurrencies like bitcoin and ether showed little correlation with major stock indices,” the IMF said. “They were thought to help diversify risk and act as a hedge against volatility in other asset classes.” After the central banks reacted to the corona crash with low interest rates, a trend reversal began here. “Both crypto prices and US stocks rallied amid looser global financial conditions and greater investor risk appetite.”
#crypto and stocks are now moving much more in tandem. New IMF research shows how this raises risks to financial stability. lake #IMFblog for more. https://t.co/B5h2x4XqzL pic.twitter.com/tcuU3cbwgR
– IMF (@IMFNews) January 12, 2022
According to data the institution has, the correlation between Bitcoin’s returns and the S&P 500 averaged just 0.01 percent in 2017-2019. However, between 2020 and 2021, the correlation coefficient jumped to an average of 0.36, as the crypto veteran and the index of the 500 largest publicly traded US companies rose and fell together. This trend is also evident in emerging markets: According to the IMF study, the correlation between Bitcoin and the MSCI Emerging Markets Index increased 17-fold in the first two years of the pandemic compared to previous years. This means that the largest cryptocurrency weighted by market capitalization has a higher correlation with the stock market than gold, investment-grade bonds or other major currencies.
Financial stability threatened
This now suggests that “contrary to initial assumptions, the benefits of risk diversification are limited.” The organization fears that negative developments in the crypto market will also spill over into the stock market and lead to its destabilization – especially in countries that can boast a high level of adoption of internet coins. With this, the organization again warns against too deep an interlocking of cryptocurrencies in the financial systems of the countries, as was observed in El Salvador last year. In September 2021, the Central American state became the first country in the world to introduce Bitcoin as legal tender – to the displeasure of the IMF. “Given the high price volatility of bitcoin, its use as legal tender poses significant risks to consumer protection, financial integrity and financial stability,” the institute wrote in a November report on the situation in El Salvador obtained by the Reuters news agency. “Because of these risks, Bitcoin should not be used as legal tender. The staff recommend narrowing the scope of the Bitcoin Act and urge greater regulation and oversight of the new payment system.”
Warning about spillover effects
The IMF now sees evidence of these risks in its study results. Studies by the institution have shown that the high price instability of Bitcoin during the Corona crisis contributed to a sixth of the volatility of the S&P 500 and a tenth of its return fluctuations. A negative consequence of the high correlation between the stock and crypto market could mean that investors scale back their investments in company shares. But not only stock trading could be affected by the interaction: “Spillover effects in the opposite direction – i.e. from the S&P 500 to Bitcoin – are similarly large on average, which indicates that sentiment in one market is in a not insignificant way transmitted to others,” the authors warn.
Stablecoins also affected
This phenomenon can also not only be observed with regular cryptocurrencies, but also refers to stablecoins, whose rates are linked to existing fiat currencies and are therefore said to have significantly lower volatility than that of Bitcoin, for example. In their text contribution, the IMF members explain that the spillover effects on the stock market can also be attributed to the dominant stablecoin Tether and have also increased significantly since the beginning of the pandemic. Compared to Bitcoin, however, the effects were significantly lower.
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Regulation should help
In summary, the organization writes that spillover effects are particularly important in times of major fluctuations in the financial markets – for example at the beginning of the Corona crisis in March 2020. In view of this warning, the IMF is repeating its call for global regulation of the crypto business . “It is therefore time to adopt a comprehensive, coordinated global regulatory framework to guide national regulation and oversight and mitigate the risks to financial stability posed by the crypto ecosystem,” the IMF blog said. “Such a framework should include regulations tailored to the key uses of cryptoassets and establish clear requirements for regulated financial institutions in relation to their exposure to and participation in those assets.” In addition, open data gaps in the trading business must be closed as quickly as possible in order to monitor such risks.
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