In a recent interview with Bruno Macchialli, CEO at Delchain, he stated that analysts have noted a growing relationship between stock markets and cryptocurrencies since the onset of the pandemic. Traditionally, the relationship between stocks and cryptos has been fragile; however, during the covid pandemic, Bitcoin’s correlation with the S&P 500 reached a market flinching 0.36 during 2020-21, up from 0.01 during 2017-19.
Crypto tends to be driven by investor sentiment rather than traditional market forces that affect commodities. Yet, these tokens are not immune to broader trends, as sentiment itself is driven by shifts in the trading world, meaning this correlation is likely to become more ingrained in the financial market.
The crypto market represents an increasingly influential player in the financial world due to its economic weight. Despite recent slumps, the crypto market cap bounced back to over $2 trillion at the end of Q1, 2022, a fourfold increase since 2017. This means that any turbulence in the market will be felt outside the crypto space. With stable cryptocurrencies taking root in many developing countries as an alternative to untrusted local fiat, a forthcoming rollout of a national framework crypto is set to become part of the financial fabric of nations.
With the crypto market becoming a global financial behemoth and more embedded in national economies, correlation with stock markets runs the risk of market spillover. This means the poor performance of one market spilling over to other markets, amplifying financial shocks. Studies have already identified market volatility spillover during the COVID pandemic between crypto and the S&P 500. With this trend likely to continue, it could lead to choppy financial seas ahead, as the force of multiple currents threatens to capsize financial systems.
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Towards a Regulatory Framework
However, this correlation and greater embeddedness into local economies may indirectly lead to the crypto market becoming more stable in the long term. The recent interconnectedness between the crypto and financial markets has fostered stronger calls for a global regularity framework to mitigate the risk of destabilization, including from the IMF. Any significant economic shocks stemming from this newfound dependency may trigger broad support from beyond the financial sector, forcing legislators to act and roll out a global framework.
One of the key strategies of a global regulatory framework will be to temper speculation. Cryptocurrencies are undulated by pervasive speculation amongst investors, who take on heavy risks with the hope of making quick and substantial gains. A well-implemented regulatory framework would likely rein in speculation, making it a more stable and appealing investment arena. This, in turn, may represent a massive boon for cryptocurrencies, drawing in many would-be investors who have been hesitant to invest in crypto due to its sheer volatility and the boom or bust stories that dominate headlines.