"Expansion of Connectivity Between Virtual Assets and Stock Markets Threatens Financial Stability... Need for Regulatory Improvements"

Korea Institute of Finance Report
"Financial Companies Must Manage Soundness"

[Image source=Yonhap News]

[Asia Economy Reporter Seo So-jeong] Recently, the connectivity between the virtual asset market and the stock market has significantly expanded, potentially threatening financial stability, prompting calls for continuous monitoring and institutional improvements regarding virtual assets.

Lee Dae-gi, Senior Research Fellow at the Korea Institute of Finance, stated in his April 4 report titled "The Impact of Virtual Assets on Financial Stability," "Although the impact of virtual assets on domestic financial stability is currently assessed as minimal, considering the growth rate of transaction volumes and the number of users, the influence of virtual assets is expected to continue expanding."

According to research cited by Senior Research Fellow Lee, the volatility and return spillover effects between the virtual asset market and the U.S. stock market were less than 2% before the pandemic but surged to between 6% and 17% after the pandemic.

The volatility spillover effect from Bitcoin to the S&P 500 index sharply increased from 1.0% to 17.0%, while the spillover effect from the stock market to the Bitcoin market also expanded significantly from 1.8% to 15.0%. During the same period, return spillover effects increased by 10 percentage points and 11.8 percentage points, respectively.

Moreover, the spillover effects between the virtual asset market and the stock market tended to increase during periods of high market volatility, such as the onset of the pandemic.

Senior Research Fellow Lee explained that as financial institutions’ direct and indirect exposure to virtual assets increases, the volatility of their profits and losses may rise, potentially destabilizing the financial system through asset quality deterioration and reputational risk. Investment losses by virtual asset investors could lead to reduced consumption and contraction of the real economy, thereby threatening financial stability.

He also pointed out that the high price volatility of virtual assets and technology and operational risks could undermine trust in the financial system, leading to large-scale bank deposit withdrawals and increased volatility in stock, bond, and foreign exchange markets. In particular, stablecoins, unlike other virtual assets, are directly connected to the financial system through reserve assets, and forced liquidation of these reserves for large-scale redemptions could amplify financial system risks.

Senior Research Fellow Lee noted, "Currently, domestic financial institutions are prohibited from directly holding or purchasing virtual assets, so their direct and indirect exposure remains minimal. However, as equity investments in virtual asset businesses and joint ventures increase, the exposure of domestic financial institutions may expand." He added, "It is necessary to assess the risks arising from the expansion of financial companies’ exposure to virtual assets and manage the soundness of financial companies through appropriate regulations, such as applying higher risk weights related to virtual assets."

Meanwhile, the number of virtual asset users in Korea has rapidly increased from 940,000 in 2019 to 1.21 million in 2020, and 5.58 million last year.

This content was produced with the assistance of AI translation services.