Technology

Despite what crypto fans say, investing in Bitcoin to hedge against market crashes is not the best idea

Cryptocurrencies have become an increasingly popular asset class among retail and institutional investors.. Although initially considered a fringe asset class, its increased adoption across countries, particularly in emerging markets, amid bouts of extreme price volatility has raised concerns about its potential implications for financial stability.

In September 2021, for example, Bitcoin and Ether ranked in the top 20 traded assets in the worldcompeting with the market capitalization of some of the largest companies in the world.

Due to the fact that prior to the pandemic, the US stock market had marked a clearly upward trend since the appearance of cryptocurrencies, it was difficult to assess how these assets behave when the market tide behaves violently and great volatility appears. Today there are already studies, such as the latest one prepared by the IMF, which give a broader vision of the existing correlations between the stock market and cryptocurrencies.

The stock market and cryptocurrencies correlation indicate that it is not a refuge

As the market capitalization of crypto assets, in particular Bitcoin, began to rise in 2017, its price showed little correlation with major stock price indices, such as the S&P 500 index.

However, this seems to have changed since the second quarter of 2020as Bitcoin and US stock prices have risen against a backdrop of easy global financial conditions and heightened investor risk appetite.

Next shows the evolution of the S&P500 stock price index and Bitcoin prices to signal the correlation between the two. While there was a relatively weak correlation between the stock market and Bitcoin in 2017, it had become even weaker by mid-2020.

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However, since June 2020, the correlation has skyrocketed, with the price of crypto assets rising 16% in Q3 2020, once again diverging from the S&P500, which was up 7% in the same period. During the last quarter of 2020, the correlation continued to rise with Bitcoin up 38% and S&P500 up 11%. With a current correlation of 0.36, Bitcoin and SPX show a significant correlation in the positive direction, suggesting that Bitcoin may be starting to act as a riskier asset..

A positive correlation means that when the stock market falls the crypto market will follow and vice versawhich gives us to understand that it does not work as an active shelter. The rise in correlations between crypto assets and equity returns since 2020 has been much more pronounced than for other key asset classessuch as the 10-year US Treasury ETF, gold, and select currencies (euro, renminbi, and US dollar).

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The correlation with corporate bonds has also increased significantly and, as tends to be the case with risky asset classes such as stocks, it is positive with high yield bonds and negative with investment grade bonds for Bitcoin and Ether.

Cryptocurrency price movements also seem to have correlated more with the misalignment of US equity prices compared to pre-pandemic years, suggesting that perhaps an excess of optimism on the part of investors may be contributing to the rise in their prices.

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Cryptocurrencies in the crosshairs of regulators

Regulators have realized that they need to consider regulating cryptocurrencies, although such regulation may be difficult to conceive of. For most regulators, cryptocurrencies are considered a speculative asset class and are not considered as currencies. Unlike fiat currencies, which are backed by the government, cryptocurrencies are backed by blockchain technology, which establishes the record of transactions and protects the integrity of the network.

Cryptocurrencies can escape international regulations... but only if they are used without layers on top: the case of OpenSea

Emerging market regulators have been involved in various ways in the cryptocurrency market. Some countries have banned the mining and trading of cryptocurrencies, while others have established regulations for their use. Some countries, like China and South Korea have banned cryptocurrency trading, while others, such as Singapore and Japan, have established regulations for its use in financial markets..

From the point of view of its impact on financial stability, regulators in emerging markets have been optimistic about the impact of cryptocurrencies on financial markets. However, there is a risk that cryptocurrencies could be used as a vehicle for money laundering and terrorist financing. The blockchain technology that supports cryptocurrencies can also be used for financial fraud.

Yet no consensus has been reached on how cryptocurrencies should be regulated in emerging markets. However, regulators in emerging markets are expected to continue to consider regulating cryptocurrencies as blockchain technology advances and becomes more widely adopted.

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