Crypto poses growing systemic risk, report says

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.

Alex Tapscott, managing director of the digital asset group at Ninepoint Partners, which manages the Ninepoint Bitcoin ETF, also noted the increasing correlation this year between Bitcoin and tech stocks.

“That tells me a couple of things: one, it’s an asset class that’s more widely held. It’s held by a lot of institutions, it’s quoted in mainstream media. So it is beginning to trade like a more conventional financial asset,” he said in an interview last month.

“But it’s also a little disappointing, because one of the big attributes of Bitcoin, historically, has been that it’s uncorrelated, which can improve measures of risk-adjusted returns when added to a portfolio.”

Tapscott said he thinks Bitcoin will regain that role of being an uncorrelated asset over the medium and longer term.

Additionally, cryptoassets can affect investor sentiment and lead to spillover effects, the TD 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.

Even as the crypto sector faced dramatic losses last month, Canadian ETF investors continued to invest in the sector.

Cryptoasset ETFs made a comeback in May with $565 million in flows — also the biggest monthly inflow so far this year for the category, a report from National Bank Financial said.

Since the crypto category’s inception last year, “close to $7 billion have flowed into this asset class,” National Bank said. “Nevertheless, the total AUM in Canadian crypto-asset ETFs is just $4.3 billion because of price declines in Bitcoin and Ethereum, a testament to how volatile and risky this new asset class can be.”

Staff

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