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:
A bitcoin trader looks afraid and holds his hands to his mouth among graphics of red arrows pointing down

Image source: Getty Images

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.

Wondering where you should invest $1,000 right now?

When investing expert Scott Phillips has a stock tip, it can pay to listen. After all, the flagship Motley Fool Share Advisor newsletter he has run for over ten years has provided thousands of paying members with stock picks that have doubled, tripled or even more.*

Scott just revealed what he believes could be the five best ASX stocks for investors to buy right now. These stocks are trading at near dirt-cheap prices and Scott thinks they could be great buys right now.

*Returns as of January 12th 2022

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