What will happen when crypto assets are no longer on the fringes of the financial system?

The connection between virtual assets and financial markets is getting closer and closer, and as the crypto market continues to develop in 2020, multiple institutions have pointed out that cryptocurrencies will no longer be marginal.

Crypto assets are no longer on the fringes of the financial system, the International Monetary Fund (IMF) further stated in its latest report. But it also expressed concerns about the risks of the crypto market. The IMF noted that with the widespread adoption of cryptoassets, the correlation between cryptoassets and traditional holdings such as stocks has increased significantly, which could soon pose risks to financial stability, especially in countries with widespread cryptocurrency adoption.

Crypto assets are no longer marginal

The total market value of encrypted assets has increased from $620 billion in 2017 to the current $2.1 trillion. At the peak, it once exceeded $3 trillion. The current market value is still nearly four times higher than in 2017. At the same time, its popularity has soared among retail and institutional investors, and it has gained widespread social discussion.

In terms of asset correlation, prior to the pandemic, cryptoassets such as Bitcoin and Ethereum had little correlation with major stock indices. They are believed to help spread risk and serve as a hedge against volatility in other asset classes. But that changed following the central bank's crisis response in early 2020. Both cryptocurrency prices and U.S. stocks surged amid easing global financial conditions and increased investor risk appetite.

For example, in 2017-2019, Bitcoin's returns did not move in a particular direction with the U.S. benchmark stock index S&P 500, their daily change correlation coefficient was only 0.01, but as assets rose or fell in tandem, The indicator jumped to 0.36 in 2020-2021. Therefore, in the past 2021, institutions including Goldman Sachs, TD Securities, etc. have pointed out that Bitcoin is not a "safe-haven asset".

Furthermore, given the popularity of crypto investing, it has risen or fallen in tandem with stock assets. Several institutions say that Bitcoin is no longer on the fringes. In December 2020, cryptocurrency rating agency Weiss Crypto Ratings tweeted that cryptocurrencies will no longer be fringe currencies. They will be finance for ordinary people. Like the passage of time, it is inevitable and unstoppable. In the same month, Finch Capital released a forecast report on European Fintech in 2022, stating that Crypto/DeFi has become mainstream, and the adoption of Crypto and DeFi by enterprises has paved the way for the global popularity of encryption. On Jan. 1, CNET’s crypto predictions for 2022 noted that crypto will go further into the mainstream.

In addition, Forbes released a prediction for the crypto market and blockchain in 2022, saying that stablecoins will become mainstream. According to the Presidential Working Group report, between October 2020 and October 2021, stablecoin utilization increased by 500%, and this rate of adoption does not appear to be trending down. Bitcoin will hit $100,000, rising inflation, continued monetary easing around the world, and the proliferation of cryptoassets all point to the conclusion that cryptoassets are here to stay.

raise risk concerns

In its latest report, the IMF further stated that the stronger correlation indicates that Bitcoin has been a risky asset. Its correlation with equities has been higher than between stocks and other assets such as gold, investment-grade bonds and major currencies, suggesting that risk diversification benefits are limited compared to initial expectations.

The increased and sizeable co-movements and spillovers between cryptocurrency markets and equity markets indicate the growing interconnectedness between these two asset classes, which enables the transmission of shocks that could destabilize financial markets. Crypto assets are no longer on the fringes of the financial system, according to IMF analysis. Given their relatively high volatility and valuations, their increased linkages could soon pose a risk to financial stability, especially in countries with widespread cryptocurrency adoption. Therefore, it is time to adopt a comprehensive, coordinated global regulatory framework to guide national regulation and mitigate financial stability risks from the crypto ecosystem.

According to the IMF, such a framework should include regulations tailored to the primary uses of cryptoassets, with clear requirements for regulated financial institutions regarding their exposure to and participation in these assets. Furthermore, in order to monitor and understand the rapid development of the crypto ecosystem and the risks it poses, the data gap created by the anonymity of such assets and limited global standards must be filled quickly.

In addition, a recent report released by the Ouke Cloud Chain Master also pointed out that Bitcoin is not a safe-haven asset, but has the attributes of a risk asset. Given the size of Bitcoin’s market capitalization, it is difficult to truly get out of the independent market, and it will definitely be affected by the market’s expectations for the economic environment and the overall sentiment.

Overall, the crypto economy is going mainstream, however, the industry is far from perfect. Investment bank and asset manager JMP Securities said the industry is still in its formative stages, regulation has yet to develop, and given the technological side of the space, the industry needs more education, making adoption and usage not always intuitive. With further maturity and time, many of the space's current perceived negatives will continue to improve.