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Cryptos/ NFTs – What lies ahead?

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The euphoria around crypto assets was thought of as a fringe activity.  The excitement around crypto-assets barely affected anything that happened in the financial markets.  However, it is not just euphoria and is not just a fringe activity either.  The value of crypto assets traded worldwide is nearly $ 3 trillion, or equivalent to India’s GDP.

A new paper by the International Monetary Fund or IMF reveals that the correlation between crypto and equity markets has increased over four years to 2021.

“Compared to pre-pandemic years, the correlation between Bitcoin price volatility and S&P 500 index volatility has increased more than four-fold,” argues the new IMF paper.  When financial markets turn volatile, the study also observes an increased spillover from Bitcoin returns to the US S&P500 returns and vice versa.

“These findings suggest that crypto-assets may no longer be considered as a fringe asset class and could potentially pose financial stability risks due to their extreme price volatility,” said the paper.

There are a lot of companies that offer trading in both stock markets and crypto-assets.  There is a growing acceptance of Bitcoin even by institutional investors, and they have positions in both markets.  The IMF calls for governments and regulators to get serious about crypto assets and its associated risks

In India, the government was expected to introduce a new bill to ban private cryptocurrencies and pave the way for a regulated digital currency.  However, it could not be taken up in the winter session of the Parliament.  Clearly, in most countries, top priorities did not include the regulation of cryptocurrencies or assets, for the present.

However, the interplay of stock markets and crypto assets could put the financial system at risk.  People could sell in one market to meet obligations in another if there is an increased correlation between the two worlds.  That could lead to a surge in volatility and hurt ordinary people looking to profit through trading and investing.

As markets get complicated, Investing in crypto-assets should be regulated just like that in stocks, bonds, real estates etc.  Use of Cryptos for payments and creating an alternate currency to sovereign currencies seem far fetched. But the Distributed Ledger Technology has the potential to support innovations built on top of it like NFTs and other new types of assets.  

There is global coordination among regulators in the stock markets and bond markets.  In an interconnected world, we have seen how problems in one market trigger panic in others. There exists no such coordinated understanding on cryptos and regulations around them.  With the US all set to taper bond buying, countries dependent on capital flows would see volatility this year.  There is a need to introduce  policy measures around crypto assets, NFTs and their associated risks.  Until such time, global financial stability is undoubtedly at risk.

References:

https://content.govdelivery.com/accounts/USIMF/bulletins/30008a1

https://www.imf.org/en/Publications/global-financial-stability-notes/Issues/2022/01/10/Cryptic-Connections-511776?utm_medium=email&utm_source=govdelivery

https://www.icicidirect.com/research/equity/one-minutes-read/digital-currency-is-it-a-game-changer-