Is Bitcoin making share prices more volatile?

The rising popularity of Bitcoin is posing a threat to financial markets and ASX investors should be alive to this risk.

| More on:
bitcoin coins falling

Image source: Getty Images

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

The rising popularity of Bitcoin is posing a threat to financial markets and ASX investors should be alive to this risk as well.

That’s according to an analysis undertaken by the International Monetary Fund (IMF). The study found a high correlation between cryptocurrencies and major share indices.

This means that cryptos, such as Bitcoin (CRYPTO: BTC) and Ethereum (CRYPTO: ETH), moved in tandem with share markets. This has implications for the ASX on a number of fronts.

The connection between Bitcoin and shares

“Crypto assets are no longer on the fringe of the financial system,” said the IMF in its blog post.

“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.”

The market value of cryptos surged to around US$3 trillion in November last year from $620 million in 2017.

Why Bitcoin is more correlated now

The connection between the digital asset class and shares didn’t quite exist till the outbreak of the COVID-19 pandemic in early 2020.

Pre-COVID, cryptos and shares moved independently. But the flood of money unleashed by central banks around the world changed that, according to the IMF.

Why ASX investors should care is because of the potential spill-over effects. For instance, if the price of Bitcoin crashes, it could trigger a sharp sell-off in global shares.

How cryptos can cause a share market crash

This isn’t as farfetched as you might think. The IMF calculated that around one-sixth of the volatility on the S&P 500 (INDEXSP: .INX) is caused by the volatility of Bitcoin.

“As such, a sharp decline in Bitcoin prices can increase investor risk aversion and lead to a fall in investment in stock markets,” added the IMF.

“Spillovers in the reverse direction—that is, from the S&P 500 to Bitcoin—are on average of a similar magnitude, suggesting that sentiment in one market is transmitted to the other in a nontrivial way.”

No safe haven for Bitcoin investors

The other follow-on effect for ASX investors to note is that Bitcoin doesn’t make a good safe haven asset. There has been plenty of talk about how Bitcoin could replace gold.

But gold has a much weaker correlation to shares. History has repeatedly shown that gold outperforms during a financial crisis, such as the GFC. As it turns out, Bitcoin could actually be a source of a financial crisis.

Another point to note is that it may only be a matter of time before global regulations are imposed on cryptos.

Foolish takeaway

If the IMF’s analysis is right, it is unlikely that governments would allow cryptos to trade without the same rules that apply to other assets in the financial system.

What’s also interesting is that the IMF article doesn’t talk about what happens when central banks withdraw stimulus.

If the sharp increase in loose monetary conditions drove an increase in correlation between crypto and shares, the question remains of whether the reverse will happen when monetary conditions tighten, as they surely will.

Motley Fool contributor Brendon Lau has no position in any of the stocks mentioned. The Motley Fool Australia's parent company Motley Fool Holdings Inc. owns shares of and has recommended Bitcoin and Ethereum. The Motley Fool Australia has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

More on Cryptocurrencies

A male investor wearing a white shirt and blue suit jacket sits at his desk looking at his laptop with his hands to his chin.
Cryptocurrencies

Can the Bitcoin price reach US$30,000 again in 2022?

Rising interest rates have resulted in significantly less institutional investor interest in cryptos.

Read more »

A man sits in despair at his computer with his hands either side of his head, staring into the screen with a pained and anguished look on his face, in a home office setting.
Cryptocurrencies

Could this key metric signal more bad news for the Bitcoin price?

Crypto investors are keeping a close eye on the signals that could see the US Federal Reserve begin to ease…

Read more »

Man sitting at a desk facing his computer screen and holding a coin representing discussion by the RBA Governor about cryptocurrency and digital tokens
Cryptocurrencies

Is it smart to use dollar cost averaging to buy Bitcoin?

Should investors consider a DCA strategy for cryptocurrencies like Bitcoin?

Read more »

A hip young guy works at his home workstation with two screens and a gamers chair, keeping an eye on his crypto investments.
Share Market News

Bitcoin price dips in August after soaring 22% in July. What’s going on?

The greater presence of institutional investors in crypto markets looks to be adding to the correlation between cryptos and other…

Read more »

A very sad beagle cross dog lays dejectedly on a sofa with his short legs stretched out in front of him in a pose of flat defeat as he stares sadly at the camera.
Cryptocurrencies

Expert panel slashes 2022 outlook for Dogecoin price. Here’s why

Originally created as a joke, Dogecoin still has a market value of nearly US$9 billion despite crashing 91% from last…

Read more »

an image of a gold bitcoin and a gold ethereum coin side by side against a backdrop of a graph with reda and green bars representing rising and falling prices.
Cryptocurrencies

Bitcoin price dips. Is Ethereum on track to dethrone the top crypto?

Bitcoin is up 22% since 1 July while Ethereum has leapt 56% higher.

Read more »

A woman holds a bitcoin token in her hand as she smiles at the camera in the background.
Cryptocurrencies

Why El Salvador is doubling down on Bitcoin despite the 2022 price crash

El Salvador still intends to issue a US$1 billion Bitcoin-backed bond, once market conditions improve.

Read more »

a mysterious person wearing a black hoodie points a finger to a vast illuminated graph tracking bitcoin value with bitcoin symbols floating above the chart.
Cryptocurrencies

The Bitcoin price is leaping 10% higher today. What’s going on?

Only a single one of the top 100 cryptos by market cap has lost value since this time yesterday.

Read more »