The Effect of COVID-19 Transmission on Cryptocurrencies

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This entry is adapted from the peer-reviewed paper 10.3390/risks11080139

Bitcoin and other cryptocurrencies like Ethereum and Dogecoin have emerged as important asset classes in general, and diversification and hedging instruments in particular. The COVID-19 pandemic has provided the chance to examine and assess cryptocurrencies’ behavior during extremely stressful times.

COVID-19 coronavirus cryptocurrency price volatility liquidity

1. Introduction

Global crises have a direct and strong effect on financial markets. Climate disasters, political upheaval, epidemics, and military conflicts can endanger our lives, infrastructure, health, and international relations. These radical changes constitute an international danger for the economy and companies. They are a source of great uncertainty that threatens investments in the financial markets. Sadly, the 2019 coronavirus pandemic fits this image because of the frustration of the global economy and warnings about the stock markets. A 30% share was quickly lost by the Canadian and US stock markets, wiping out several gains made over the past decade. A considerable number of research studies have revealed why the COVID-19 pandemic plunged the financial markets into a whirlwind, why this crisis is unique, and how business leaders and governors can support the economy during this particularly busy time. During a time of bleak growth prospects, low inflation, and low interest rates, the pandemic had significant effects. The coronavirus pandemic and its associated measures, such as social distancing and confinement, were not without drawbacks in the economic sphere. In fact, they generated a decline in production, a reduction in tax revenues, an increase in expenditure, and enhanced assistance to the most affected families and businesses to cover them against unemployment, bankruptcy, and loss of income. This led to both a deterioration in the budget balance of most countries and an increase in the public debt ratio for others, as confirmed by the IMF (2020) in its report related to COVID-19’s effects on global public finances, published in April 2020.

According to a World Bank report published in 2020, the coronavirus pandemic destabilized the world economy, causing a recession resulting from the activity decline noticed in the first quarter of 2020 in China, which was expected to cover other affected countries, namely the United States and the Eurozone. We have also witnessed a reduction in commodity prices, especially the prices of petroleum and industrial metals, as well as global extreme volatility in the stock markets due to uncertainty over time and the possible future consequences of this pandemic, not to mention the devaluation of currencies in emerging and developing economies, such as the outflow of capital from these economies exceeding those of the 2008 financial crisis.

Since we are interested in financial market instability, the IMF (2020) noted in its Global Financial Stability Report that the global financial markets were significantly affected by the coronavirus pandemic, causing a sharp decline in stock prices, a widening of credit spreads in the markets, and a lowering of oil prices as well as bond yields. The widened divergence in asset prices quickly led to the tightening of financial conditions. There were short-term financial pressures in the core funding markets and a sharp deterioration in market liquidity. Regarding the consequences of the health crisis on the banking and financial system, several researchers, such as Aguir (2018), Beck (2020), Corbet et al. (2022), Boone (2020), and Ashraf (2020), emphasize financial instability over time in the absence of appropriate response measures, which include the apparent absence of sincere communication from authorities on the pandemic; a lack of liquidity; a lack of assistance for companies and families at risk; a lack of communication between supervisory bodies and banks; inadequate response measures; solvency problems for companies, households, and banks, leading to an increase in non-performing loans; fears of contagion effects after interbank interconnection, uncertainty, and mismanagement of credit risk; and a lack of international cooperation for national regulations.

The coronavirus destabilized China and the world, leading to a deterioration in the balance of payments, which, in turn, decreased foreign exchange reserves and increased consumption and inflation. However, a decline in exports was recorded with a fall in the global demand for minerals and commodity prices, which reduced public revenue and increased the public deficit as public spending increased. All of this translates into a spike in inflation, fueling uncertainty and instability. As a result, family well-being deteriorates, economic activity contracts, and unemployment increases.

2. COVID-19 and Cryptocurrencies

The COVID-19 pandemic has moderately spread around the world, causing economic recession and imposing heavy economic penalties on the economy. However, effective action to combat this pandemic by determining the socioeconomic factors that can generate significant benefits for global economic development can prevent losses resulting from reduced trade and FDI tourism flows that undermine long-term economic growth (Aysan et al. 2020).

The world is facing the threats of COVID-19, which are breaking down and destroying the economy via various channels. Demir et al. (2020), Zaremba et al. (2020), and Kristoufek (2020) explore the volatility relationship between “Bitcoin” and the Chinese stock markets. This relationship has considerably tightened during COVID-19.

The recent COVID-19 pandemic has acted as a rigorous stress test for global markets (Iqbal et al. 2021). Not only has this pandemic caused significant disruptions in equity and commodity markets worldwide, leading to negative returns, but it has also introduced a higher level of uncertainty and volatility, affecting the cryptocurrency markets as well. This contagion has created a unique situation, which is difficult to explain in modern financial history (Baker et al. 2020; Khan et al. 2023). It is notable that any period of financial stress can have a ripple effect on cryptocurrency markets. Recent research indicates that the transmission of stress occurs from traditional to crypto markets, which causes investors to avoid crypto assets during financial crises (Matkovskyy and Jalan 2019). This is primarily due to the significant changes in the distribution of cryptocurrency returns, particularly for Bitcoin, as demonstrated by the copula-based quantile models (Bouri et al. 2018). Furthermore, a study conducted on a diverse sample of 30 different indices and 973 cryptocurrencies revealed that cryptocurrencies’ safe haven characteristic is contingent upon both the specific market and region. Additionally, their capacity to hedge against market risks is found to be quite limited (Wang et al. 2020). Since the early days of the pandemic, Bitcoin has shown a strong correlation with stock markets and lost value with other financial markets as a result of a lack of demand for risky assets, i.e., a lack of demand in an undetermined situation (Borgards and Czudaj 2020). Still, some studies found that cryptocurrencies do not behave like traditional assets, including stocks, commodities, and currencies. Hence, investors’ enthusiasm is driven by news and extreme events, which causes cryptocurrency returns to increase (Liu and Tsyvinski 2018; Rognone et al. 2020). After encountering contrasting findings regarding the behavior of cryptocurrencies, it becomes intriguing to scrutinize the efficacy of these assets amidst the recent pandemic—a highly exceptional occurrence distinguished by unparalleled attributes. Several scholars have endeavored to chronicle the ramifications of this global health crisis, shedding light on its implications for cryptocurrencies on the yields of Bitcoin. They discovered that its performance was lackluster in such circumstances and demonstrated a significant correlation with stock markets (Conlon and McGee 2020). A few researchers have even drawn comparisons between Bitcoin and gold, reaching the conclusion that Bitcoin does not live up to its reputation as “digital gold” (Conlon and McGee 2020). Gold, once again, has proven its superiority as a natural hedge against market catastrophes similar to the current pandemic. Certain rational voices have advised individuals to temper their expectations regarding Bitcoin’s capabilities, considering it to be more of a hedge against fiat currency rather than a safeguard against significant market downturns and failures, as highlighted in a recent study by Ali (2020). In the face of adversity, Bitcoin seems to be receiving widespread criticism, as it is considered to be a total failure in the recent market turmoil. Only a few, if any, paid attention to the fact that a detailed analysis of the situation is not symmetrical; rather, only specific market conditions related to S&P and Bitcoin mounts are rented from co-movements (Bouri et al. 2017). Likewise, another study reported that nonlinear methodologies more effectively extract the asymmetric impact of negative and positive news in relation to cryptocurrency markets (Bouri et al. 2018; Katsiampa et al. 2019).

Volatility presents distinct asymmetry in comparison to the equity markets, showing a greater sensitivity to negative shocks compared to positive shocks induced by noisy traders (Baur and Dimpfl 2018) in the cryptocurrency market. Bouri et al. (2018) suggest using non-linear and non-traditional techniques to study Bitcoin behavior in order to unravel its hidden patterns and characteristics. Using such a literature guide, it is necessary to determine whether the recent COVID-19 outbreak has an asymmetric impact on the returns of major cryptocurrencies. For example, large and small increases in the pandemic severity can differently affect the cryptocurrency market not only in its entirety but also in the case of bullish and bearish scenarios.

References

IMF. 2020. World Economics Outlook, a Long and Difficult Ascent. Available online: https://www.imf.org/en/Publications/WEO/Issues/2020/09/30/world-economic-outlook-october-2020 (accessed on 14 March 2023).
Aguir, Abdelkader. 2018. Central bank credibility, independence, and monetary policy. Journal of Central Banking Theory and Practice 7: 91–110.
Beck, Thorsten. 2020. Finance in the times of coronavirus. In Economics in the Time of COVID-19. London: CEPR Press, vol. 73, pp. 73–76.
Corbet, Shaen, Yang Greg Hou, Yang Hu, Charles Larkin, Brian Lucey, and Les Oxley. 2022. Cryptocurrency liquidity and volatility interrelationships during the COVID-19 pandemic. Finance Research Letters 45: 102137.
Boone, L. 2020. Tackling the fallout from COVID-19. In Economics in the Time of COVID-19. Edited by Richard Baldwin and B. Weder Di Mauro. London: CEPR Press.
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Aysan, Ahmet, Farrukh Kayani, and Umar Nawaz Kayani. 2020. The Chinese inward FDI and economic prospects amid COVID-19 crisis. Pakistan Journal of Commerce and Social Sciences 14: 1088–105.
Demir, Ender, Mehmet Huseyin Bilgin, Gokhan Karabulut, and Asli Cansin Doker. 2020. The relationship between cryptocurrencies and COVID-19 pandemic. Eurasian Economic Review 10: 349–60.
Zaremba, Adam, Renatas Kizys, David Y. Aharon, and Ender Demir. 2020. Infected markets: Novel coronavirus, government interventions, and stock return volatility around the globe. Finance Research Letters 35: 101597.
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Ali, Inayat. 2020. COVID-19: Are we ready for the second wave? Disaster Medicine and Public Health Preparedness 14: e16–e18.
Bouri, Elie, Rangan Gupta, Aviral Kumar Tiwari, and David Roubaud. 2017. Does Bitcoin hedge global uncertainty? Evidence from wavelet-based quantile-in-quantile regressions. Finance Research Letters 23: 87–95.
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Nesrine Dardouri

Abdelkader Aguir

Mounir Smida

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Update Date: 08 Aug 2023

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1. Introduction

2. COVID-19 and Cryptocurrencies

References