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Crypto Prices Move More in Sync With Stocks, Posing New Risks

(Photo: da-kuk/iStock by Getty Images)

By Tobias Adrian, Tara Iyer and Mahvash S. Qureshi

There’s a growing interconnectedness between virtual assets and financial markets.

Crypto assets such as Bitcoin have matured from an obscure asset class with few users to
an integral part of the digital asset revolution, raising financial stability concerns.
The market value of these novel assets rose to nearly $3 trillion in November from $620
billion in 2017, on soaring popularity among retail and institutional investors alike,
despite high volatility. This week, the combined market capitalization had retreated to
about $2 trillion, still representing an almost four-fold increase since 2017.
Amid greater adoption, 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, according to new IMF
research.
Bitcoin, stocks move together
Before the pandemic, 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. But this changed after 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.
For instance, returns on Bitcoin did not move in a particular direction with the S&P 500,
the benchmark stock index for the United States, in 2017–19. The 60-day correlation
coefficient of their daily moves was just 0.01, but that measure jumped to 0.36 for
2020–21 as the assets moved more in lockstep, rising together or falling together.
The stronger association between crypto and equities is also apparent in emerging
market economies, several of which have led the way in crypto-asset adoption. For
example, correlation between returns on the MSCI emerging markets index and Bitcoin
was 0.34 in 2020–21, a 17-fold increase from the preceding years.
Stronger correlations suggest that Bitcoin has been acting as a risky asset. 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.

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Crypto’s ripple effects
Increased crypto-stocks correlation raises the possibility of spillovers of investor
sentiment between those asset classes. Indeed, our analysis, which examines the
spillovers of prices and volatility between crypto and global equity markets, suggests
that spillovers from Bitcoin returns and volatility to stock markets, and vice versa, have
risen significantly in 2020–21 compared with 2017–19.
Bitcoin volatility explains about one-sixth of S&P 500 volatility during the pandemic,
and about one-tenth of the variation in S&P 500 returns. As such, a sharp decline in
Bitcoin prices can increase investor risk aversion and lead to a fall in investment in stock
markets. Spillovers in the reverse direction—that is, from the S&P 500 to Bitcoin—are
on average of a similar magnitude, suggesting that sentiment in one market is
transmitted to the other in a nontrivial way.
Similar behavior is visible with stablecoins, a type of crypto asset that aims to maintain
its value relative to a specified asset or a pool of assets. Spillovers from the dominant
stablecoin, Tether, to global equity markets also increased during the pandemic, though
remain considerably smaller than those of Bitcoin, explaining about 4 percent to 7
percent of the variation in US equity returns and volatility.
Notably, our analysis shows 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.
Systemic concerns
The increased and sizeable co-movement and spillovers between crypto and equity
markets indicate a growing interconnectedness between the two asset classes that
permits the transmission of shocks that can destabilize financial markets.
Our analysis suggests that crypto assets are no longer on the fringe of the financial
system. 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. It is thus time to adopt a comprehensive, coordinated
global regulatory framework to guide national regulation and supervision and mitigate
the financial stability risks stemming from the crypto ecosystem.
Such a framework should encompass regulations tailored to the main uses of crypto
assets and establish clear requirements on regulated financial institutions concerning
their exposure to and engagement with these assets. Furthermore, to monitor and
understand the rapid developments in the crypto ecosystem and the risks they create,
data gaps created by the anonymity of such assets and limited global standards must be
swiftly filled.

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Tobias Adrian is the Financial Counsellor and Director of the IMF’s Monetary and
Capital Markets Department. He leads the IMF’s work on financial sector surveillance
and capacity building, monetary and macroprudential policies, financial regulation, debt
management, and capital markets. Prior to joining the IMF, he was a Senior Vice
President of the Federal Reserve Bank of New York, and the Associate Director of the
Research and Statistics Group. Mr. Adrian has taught at Princeton University and New
York University, and has published in economics and finance journals, including the
American Economic Review and the Journal of Finance. His research focuses on the
aggregate consequences of capital market developments. He holds a PhD from the
Massachusetts Institute of Technology; an MSc from the London School of Economics; a
Diplom from Goethe University Frankfurt; and a Maîtrise from Dauphine University
Paris.

Tara Iyer is an economist in the Global Financial Stability Analysis Division of the
IMF’s Monetary and Financial Markets Department, where she contributes to the Global
Financial Stability Report. Tara’s current research focuses on issues related to mutual
funds, crypto assets, and monetary policy in emerging markets. Prior to joining the IMF,
Tara worked at the Asian Development Bank and was a fellow at Harvard University.
Tara received her MPhil and PhD in economics from the University of Oxford, and her
BSc in economics from Duke University. In her previous career, Tara was a professional
tennis player.

Mahvash S. Qureshi is a division chief in the IMF’s Monetary and Capital Markets
Department, where she heads the Global Financial Stability Analysis Division and
oversees production of the analytical chapters of the Global Financial Stability Report.
Previously, she was deputy division chief in the Research Department and in the
Regional Studies Division of the African Department. Her research focuses on issues
related to the stability of the international monetary and financial system, including
exchange rate regimes, external balance dynamics, capital flows and capital controls, as
well as international trade and development. She has published extensively on
international macroeconomic policy issues in scholarly journals and is the author and
editor of several books including Taming the Tide of Capital Flows (MIT Press, 2017).
She received her Ph.D. and MPhil. in economics from University of Cambridge, Trinity
College.