The increasing correlation between cryptocurrency trading and equity markets – especially in Asia – could be contagious. Large crypto losses for individual or institutional investors who hold both crypto and traditional financial assets and liabilities could drive them to rebalance their portfolios, causing financial market volatility or even defaults on traditional liabilities.
Before the pandemic, the cryptocurrency world seemed isolated from financial markets. Bitcoin and other crypto instruments  showed little correlation with equity market performance. Cryptocurrencies were even regarded as helpful in diversifying risk and as a hedge against swings in other asset classes.
However, since the Covid-19 crisis, the correlation between crypto and equity market movements has risen sharply, meaning that the financial sector may not be insulated from future crypto boom-bust cycles. Arguably, it also adds to the incentive for central banks to develop central bank digital currencies (CBDCs) as a means to regulate the crypto market and manage its risks.
The rising correlation
Research  shows that between 2017 and 2019, the correlation coefficient of Bitcoin’s daily market movement and that of the S&P 500 equity index was just 0.01. However, that jumped to 0.36 between 2020 and 2021. A similarly sharp increase was seen in the correlation between returns on the MSCI Emerging Markets index and Bitcoin rising to 0.34 in 2020–21 from only 0.02 in the preceding years.
Crypto trading has soared since the pandemic, as millions of locked-down people jumped on the digital trading bandwagon. Low interest rates and easy financing conditions further boosted flows into the crypto market. Governments’ pandemic relief cash handouts also contributed.
However, the crypto market is volatile. The world’s crypto market capitalisation surged 20-fold to USD 3 trillion from June 2020 to December 2021, according to the International Monetary Fund. It then abruptly shrank to less than one trillion dollars in June 2022 when central banks began to tighten monetary policy to fight inflation.
Greater crypto/equity market correlation raises the possibility of spill-overs from one market to the other. Contagion could spread when individual or institutional investors who hold both crypto and traditional financial assets and liabilities suffer large losses in volatile crypto markets. Were these investors to rebalance their portfolios, it could cause greater financial market volatility or even lead to defaults on traditional liabilities.
Asia’s major crypto markets include India, Vietnam and Thailand, all of which have witnessed a sharp rise in crypto/equity correlation (see Exhibit 1). This growing interconnectedness between crypto and stock markets facilitates the transmission of shocks that could destabilise the financial system.
Sensitive to this rising risk and seeking to manage it, some Asian central banks are imposing regulations on the crypto market and creating their own digital currencies.
China went to the extreme of banning all Bitcoin trading, mining and transactions in 2021 and creating the world’s first CBDC, the ‘Digital Currency Electronic Payment’ (DCEP) with centralised control, in 2014. 
Central banks digital currencies
According to the Atlantic Council,  the number of countries exploring the CBDC idea has risen from 35 in 2020 to more than 105, representing over 95% of global GDP. The main motives are to improve financial access and inclusion and facilitate payment and settlement. 
So far, most CBDC development is concentrated in the emerging markets, half of it in Asia. China is leading the efforts, with 23 cities now participating in the DCEP experiment.
Crucially, the People’s Bank of China (PBoC) launched the Multiple CBDC Bridge (or mBridge) project in Hong Kong in 2021 with the Bank for International Settlements, the Hong Kong Monetary Authority, the Central Bank of Thailand (BOT) and the Central Bank of the United Arab Emirates.
This project explores the potential of digital currencies and distributed ledger technology (DLT) for delivering real-time, cheaper and safer cross-border payments and settlements. It could challenge the USD-based SWIFT  system.
Disrupting the crypto disruption
Some countries are more cautious. The Monetary Authority of Singapore, for example, has been exploring CBDC applications for more than five years and sees no pressing need for a retail CBDC. Others, notably in Europe and the US, have concerns about CBDC, especially with regard to data security and privacy.
While the advent of cryptocurrencies looks set to disrupt the global financial system, the evolution of CBDC will likely act as a regulatory constraint on their development. Arguably, China’s anti-crypto policy is disrupting the crypto disruption process.
 We have our doubts about cryptocurrencies such as Bitcoin as an asset, though they are investible. See What is the problem with cryptocurrency (bitcoin)?”
 Iyer, Tara (2022), “Cryptic Connections: Spillovers between Crypto and Equity Markets”, Global Financial Stability Notes, Monetary and Capital markets, IMF, January. Retrieved from https://www.imf.org/en/Publications/global-financial-stability-notes/Issues/2022/01/10/Cryptic-Connections-511776
 “Chi Time: Crypto-Renminbi to Challenge the US Dollar”, May 2020, “Chi on China: The Crypto-Renminbi’s Disruption to the Market, Economic Growth and Policy”, August 2020, and “Chi on China: The Inherent Risks of Cryptocurrencies – When Bitcoin Meets CBDC”, May 2021.
 “Central Bank Digital Currency Tracker”, Atlantic Council. Retrieved from https://www.atlanticcouncil.org/cbdctracker/
 “Chi on China: The Crypto-Renminbi’s Disruption to the Market, Economic Growth and Policy”, August 2020
 Society for Worldwide Interbank Financial Telecommunication
This material is issued and has been prepared by BNP PARIBAS ASSET MANAGEMENT Asia Limited (the “Company”), with its registered office at 17/F, Lincoln House, Taikoo Place, Quarry Bay, Hong Kong. BNP PARIBAS ASSET MANAGEMENT Asia Limited in Australia is an authorised representative of BNP PARIBAS ASSET MANAGEMENT Australia Limited ABN 78 008 576 449, AFSL 223418 (“BNPP AMAU”). This material is distributed in Australia by BNPP AMAU. This material has not been reviewed by the Hong Kong Securities and Futures Commission. This material is produced for information purposes for wholesale investors only and does not constitute:
1. an offer to buy nor a solicitation to sell, nor shall it form the basis of or be relied upon in connection with any contract or commitment whatsoever or
2. investment advice.
This material makes reference to certain financial instruments authorised and regulated in their jurisdiction(s) of incorporation.
No action has been taken which would permit the public offering of the financial instrument(s) in any other jurisdiction, except as indicated in the most recent prospectus, offering document or any other information material, as applicable of the relevant financial instrument(s) where such action would be required, in particular, in the United States, to US persons (as such term is defined in Regulation S of the United States Securities Act of 1933). Prior to any subscription in a country in which such financial instrument(s) is/are registered, investors should verify any legal constraints or restrictions there may be in connection with the subscription, purchase, possession or sale of the financial instrument(s).
Investors considering subscribing to the financial instrument(s) should read carefully the most recent prospectus, offering document or other information material for further details including the risk factors and consult the financial instrument(s’) most recent financial reports. These documents are available from your local BNPP AM correspondents, if any, or from the entities marketing the Financial Instrument(s).
Opinions included in this material constitute the judgement of the Company at the time specified and may be subject to change without notice. The Company is not obliged to update or alter the information or opinions contained within this material. Investors should consult their own legal and tax advisors in respect of legal, accounting, domicile and tax advice prior to investing in the financial instrument(s) in order to make an independent determination of the suitability and consequences of an investment therein, if permitted. Please note that different types of investments, if contained within this material, involve varying degrees of risk and there can be no assurance that any specific investment may either be suitable, appropriate or profitable for an investor’s investment portfolio.
Investments involve risks. Given the economic and market risks, there can be no assurance that the financial instrument(s) will achieve its/their investment objectives. Returns may be affected by, amongst other things, investment strategies or objectives of the financial instrument(s) and material market and economic conditions, including interest rates, market terms and general market conditions. The different strategies applied to financial instruments may have a significant effect on the results presented in this material. Past performance is not a guide to future performance and the value of the investments in financial instrument(s) may go down as well as up. Investors may not get back the amount they originally invested.
The performance data, as applicable, reflected in this material, do not take into account the commissions, costs incurred on the issue and redemption and taxes.
All information referred to in the present document is available on www.bnpparibas-am.com