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 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.