Strong growth, increased correlation and interconnection drives rising risk
Cryptoassets pose a growing risk to financial stability and will bring increased attention from regulators, says a new report from TD Economics.
While the crypto market remains small relative to the global equity market, the sector has grown rapidly over the past couple of years and has demonstrated a closer correlation with stock markets, rising from essentially zero in the 2017-2019 period to 0.4 in 2020-2021, the report said.
Alongside the increased correlation, linkages to the traditional financial system have grown too, the report noted.
“Efforts by crypto-asset issuers to buttress the asset class necessarily increase linkages to the traditional financial system, either by drawing in more retail investors, often with leveraged exposure, or by issuing crypto-assets backed by assets in the traditional financial system,” TD said.
Additionally, cryptoassets can affect investor sentiment and lead to spillover effects, the report said.
“Investors may sour on other assets during a run that hurts their net worth,” it said. “Knock-on effects from this point become possible, especially when the stablecoins were used for leveraged trading. The loss of net worth can force investors to sell other assets to meet their cash needs.”
As a result, it said that there’s a real risk that turmoil in a major cryptoasset “would lead to broader market volatility and economic harm.”
These rising systemic risks are expected to continue attracting increased attention from both policymakers and investors, the report concluded.
Source: Investment Executive