Cryptocurrencies are no longer an unpopular asset in today’s world. The rate at which these digital assets are being embraced across populations has evoked concern from certain members of the International Monetary Fund (IMF). Considering that “crypto assets are no longer on the fringe of the financial system”, the staff of IMF is calling for a global framework that can guide the regulation and supervision of crypto assets. “There’s a growing interconnectedness between virtual assets and financial markets,” stated a report written by Tobias Adrian, Tara Iyer, and Mahvash S Qureshi working at IMF.
The report added that cryptocurrencies such as Bitcoin have evolved from an obscure asset class that had a few users initially and have gone on to become a huge part of the digital asset revolution. In the process, they have raised concerns related to financial stability.
According to the report, the market value of the crypto assets rose to nearly $3 trillion in November 2021, from $620 billion in 2017. That suggests a rise of over three times. Despite volatility, these assets have been widely adopted by retail and institutional investors alike.
The correlation of crypto assets with traditional holdings like equities has increased dramatically as adoption has grown, according to the report.
According to IMF research, the correlation between cryptocurrency assets and traditional holdings “raises the risk of contagion across financial markets”.
The report added that considering cryptocurrencies’ high volatility and valuation, their “increased co-movement” could pose challenges to financial stability, especially in countries where cryptocurrency use is prevalent.
The authors conclude that it’s, therefore, necessary to develop a “comprehensive, coordinated global regulatory framework” to guide national legislation and supervision and alleviate the financial stability risks posed by the cryptocurrency ecosystem.
The paper was written after an analysis of the spill-overs of prices and volatility between crypto and global equity markets, which have risen manifold in 2020-21 as compared with 2017-19. This could have been a result of the liquidity undertaken by central banks during the COVID-19 pandemic.
Considering the increasing risks entailed by the interconnectedness between crypto and equity markets, the IMF staff suggested a global regulatory framework to contain the main uses of crypto assets and the requirements for financial institutions dealing with these assets.