The chapter attempts to test the hypothesis that cryptocurrencies are real independent financial instruments that pose no danger to global financial system stability. For the empirical analysis, the authors use data related to bitcoin and widely traded asset classes. They also utilize the copula approach as well as the CoVaR model. The results show a significant role of crypto-asset market in the stability of global markets. Precisely, they find a dependence between bitcoin and oil prices defined by a normal copula model. The empirical results regarding the systemic risk show that extreme changes in bitcoin prices may have an adverse effect on equity and gold markets. There are positive and significant effects of EUR, JPY, and WTI markets when bitcoin goes down. The authors have also shown that after 2016 the virtual market sudden changes are more likely to raise the whole regular financial system losses, except the energy market. These results are important for policymakers and investors.
TopIntroduction
Since its creation in 2009, the usage of Bitcoin has dramatically increased much higher than expected. This dramatic increase has served to embolden the launch of other crypto-assets and brand-new derivative products (e.g. Bitcoin futures and options contracts introduced by CBOE and MSE).1 The Blockchain technology has led to the development of these markets by capturing the trust of huge users. The crypto ecosystem has thus changed to a big concurrent to mainstream financial system.
As the economic system is becoming more and more digital, the exposition of traders to risk will also increase. The cryptocurrency traders worldwide can face risks associated generally with a combination of factors such as: liquidity conditions, volatile market price swings or flash crashes, leverage of users, and market manipulation. In addition, crypto markets are not regulated by the same controls or customer protections available with regular markets. It is worth to note that these are not all risks of cryptocurrency traders. We should certainly need more experimental and analytical observation studies to document all crypto market risks.
In this chapter, we will first look at the key factors to be taken into account to better understand the risks related to digital markets. We will then discuss the contagion risk from these markets which may be spread to mainstream financial system and highlight the diverse transmission mechanisms and tools that related them to other global markets. This is the main motivation of our study since there is now a growing fear among policymakers and analysts that these digital markets could cause the next global crisis. This is similar to fears, on the role of derivatives markets in financial meltdowns.2 In this context, a mature body of literature (Stein (1987), Conrad (1989), Bessembinder et al. (1992), among others) has often shown that the phenomenal growth of derivative markets is broadly conducive to global financial crisis, which may raise the question as to whether a similar conclusion can be held for crypto markets.
In line with the Financial Stability Board (FSB) report submitted to the G20 Finance Ministers and Central Bank Governors ahead of their meeting in Buenos Aires on 19-20 March, 2018, the present chapter attempts to test empirically the following hypothesis:
It is important to note that there is now an outstanding growth in papers that analyse cryptocurrencies as investment assets (e.g. Cheah and Fry (2015)) or as hedging and safe haven assets (e.g. Bouri et al., 2017b), and as speculative assets instead of functioning as money (e.g., Urquhart (2016), Bariviera (2017)). There are also other papers that focus on the technical aspects and stylized facts of cryptocurrency markets (e.g. Dwyer (2015), Bariviera et al. (2017)) and their risk/return profile (e.g. Liu and Tsyvinski (2018)). The relationship between the digital asset and other global assets are also achieved by Trabelsi (2017) and Corbet et al. (2018). This study seeks to contribute to this small but fast growing economic literature on cryptocurrencies. Precisely, we will take a different approach from previous research, which investigated the contagion risks and captured distress dependence, to assess the systemic risk of cryptocurrencies in the whole economic system. To the best of our knowledge this is the first study that mixed the copula approach and the systemic risk measures of Adrian and Brunnermeier (2016), to investigate the relation between the nascent market of crypto-assets and the regular market defined by selected traded assets such as fiat money, equity markets, and commodities. The time span for this study is from February 02, 2012 to March 08, 2019. Unlike previous studies (e.g. Trabelsi (2017) and Bouri et al. (2018)), our empirical framework takes into account the linear and the non-linear dependence features between series, as well as the relationship among the centre and tails of distributions. We believe that the findings of this chapter will hopefully fill a significant gap in the empirical studies seeking to avoid the fears of crypto markets’ systemic risk.