The IMF published another blog about bitcoin and crypto. This time, concerns were raised about the increased Correlation between bitcoin and stocks, potentially fuelling financial instability. In 2020, according to asset manager Fidelity, we wrote that there was little Correlation between bitcoin and shares. This article will find out what’s left of the 2020 paradigm. If you want to start bitcoin trading, check if you should invest in bitcoin even knowing they are volatile.
In 2019 and 2020, there were various voices from the traditional financial sector that bitcoin might be an excellent way to diversify a broadly diversified investment portfolio. One of the unique features of bitcoin is that it offers to hedge against inflation and the prospect of a higher return than other investments. However, this was not the main argument from the possible diversification advantage to be gained. Instead, the reason can be summed up into the “low correlation with assets”.
What is Correlation in context with virtual currency?
What’s the meaning of this? According to Van Dale, Correlation indicates a mutual relationship of interdependence. In short, Correlation means coherence. For example, in the financial sector, the Correlation between different stocks is calculated to put together a balanced investment portfolio. However, several asset managers, including Fidelity and VanEck, have calculated the Correlation between bitcoin and other asset classes and concluded that it was shallow.
The value of the correspondence coefficient is always between -1 and +1. But what do the numbers in the table above mean? A correlation of 1 is a sign that it is a positive correlation. On the other hand, -1 shows the negative Correlation. Which means the variables travel in an identical path with each other? Which means the variables travel in contradictory directions? 0 shows that there is no relation.
In the table above and the chart below, we see that the Correlation between bitcoin and the S&P 500, a stock index that includes the 500 largest companies in the United States, is historically negative. However, in 2021, the Correlation between the S&P 500 and bitcoin appears to have increased again. At the end of 2021, the 100-day correlation coefficient stood at 0.33, Bloomberg reported. This was one of the highest measured values of 2021. However, the increased Correlation remains low. So we don’t know precisely what it means yet. One of the risks is that a correction in the financial markets may have a more significant impact on bitcoin than before.
IMF Blog
The IMF blog opens with the above quote. Subsequently, the blog pays attention to the growth of the crypto and bitcoin market. According to the IMF, the greater acceptance of Bitcoin, among others, has led to a significant increase in the Correlation with equities. This has eliminated bitcoin’s diversification advantage in an investment portfolio and increased the “risk of economic contagion” between the bitcoin market and traditional financial markets, leading to financial instability, according to new research from the IMF.
Furthermore, the new IMF research examines the interconnectedness and potential spillovers between crypto and bitcoin markets and traditional financial markets. According to the IMF, the increased Correlation between bitcoin and equities can be attributed to the extraordinary actions of central banks in response to the corona crisis in early 2020.
Somewhat remarkable and perhaps also somewhat arbitrary, the periods were chosen to compare the Correlation between bitcoin and equities seem. The 2017-2019 periods are compared in the study with the 2020-21 periods. Although the Correlation has increased significantly in the period 2020-21, the period before 2017 is not considered so the outcome may be slightly higher.
The IMF’s research proposes that recently crypto, such as bitcoin, is not on the fringes of the economic system. However, the IMF said that this could create financial instability given the increased Correlation between bitcoin and equities and the high volatility and valuations of crypto and bitcoin. The IMF, therefore, again calls for harmonized regulations at the global level for, among other things, bitcoin that is comprehensive, consistent, and coordinated.
It is perhaps too early to talk about a fundamental paradigm shift. While the Correlation between bitcoin and stocks appears to be increasing, we don’t know how this will develop in the future.
