From India to Vietnam and Thailand, Asia has seen a rapid adoption of crypto assets, with top adopters including individuals and institutions. Cryptocurrency integration into the Asian financial system is therefore an important issue. A digital payment system can contribute to environmental protection, financial inclusion, and financial stability.
It appeared that crypto was isolated from the financial system before the pandemic. Financial stability concerns were diffused by the low correlation between bitcoin and Asian equity markets.
In addition to government assistance and low interest rates, crypto trading soared as millions stayed home and received government assistance. Global crypto assets were worth $3 trillion in December, a 20-fold increase in just a year and a half. Those cheap borrowing opportunities ended when interest rates were raised by central banks to contain inflation in June.
However, it may not be insulated from future boom-bust cycles when sharp movements occur in the financial sector. Crypto and traditional financial assets or liabilities may be held by individuals or institutions that may be susceptible to contagion. These investors may rebalance their portfolios as a result of large crypto losses, possibly causing financial-market volatility or even default on traditional obligations.
Asia’s equity markets have correlated more closely with crypto assets, such as Bitcoin and Ethereum, since investors piled into crypto assets. Bitcoin and Asian equity markets used to have low correlations between returns and volatility before the pandemic, but these have become significantly stronger since 2020.
Cryptocurrencies offer limited risk diversification benefits, as evidenced by their return correlations with Indian stock markets over the pandemic. There has been an increase in volatility correlations three-fold, suggesting a spillover of risk sentiment between crypto and equity markets.
As crypto platforms and investment vehicles become more accepted on the stock market and over-the-counter in Asia, key factors may be responsible for increasing the interconnectedness of crypto and equity markets in Asia, or more generally, retail and institutional investors in Asia, many of whom own both equity and cryptocurrency positions, are adopting crypto for investment.
The rise in crypto-equity correlations in Asia has also been accompanied by a sharp rise in crypto-equity volatility spillovers in India, Vietnam, and Thailand according to the spillover methodology we developed in our January Global Financial Stability Note. It indicates that financial markets are becoming increasingly interconnected, allowing shocks to be transmitted between asset classes.
As crypto adoption continues to spread, Asian authorities are becoming increasingly concerned about the risks that crypto poses. In addition to India, Vietnam, and Thailand, they have increased their focus on crypto regulation.
Domestic and international regulators must also address significant data gaps that prevent them from fully understanding crypto ownership and use and how it intersects with traditional financial services.
There should be a tailored regulatory framework for crypto assets in Asia in order to accommodate the main uses of such assets. It is important that they establish clear guidelines concerning regulated financial institutions and seek to protect retail investors through education and notification.
In addition, crypto regulation needs to be tightly coordinated across jurisdictions in order to be fully effective.
