Cryptocurrency and Financial Stability: An Investigation into the Effects of Bitcoin ETFs

Abstract The approval of Bitcoin ETFs by the Securities and Exchange Commission (SEC) on 01/11/2024 was an essential event for both the cryptocurrency market and the traditional financial system. Bitcoin ETFs work as a bridge between digital assets and traditional financial instruments, contributing to increased liquidity and attracting new institutional investors who were reluctant before due to regulatory and security concerns. This study assesses the impact of the approval of Bitcoin ETFs on the stability of the financial system, focusing on the correlations and the volatility spillover effects of Bitcoin and three major financial indices (S&P 500, Dow Jones Industrial Average, and Nasdaq-100). Using Pearson Correlation, Time-Varying Parameter Vector Autoregression (TVP-VAR) and Generalized Autoregressive Conditional Heteroskedasticity (GARCH) models, this research offers a comprehensive analysis of the influence of Bitcoin on the dynamics of market. The results show that, although the correlations between Bitcoin and stock market indices reached a peak in 2021, they dropped later, suggesting a gradual decoupling from traditional financial markets. However, after the launch of Bitcoin ETFs in 2024, the correlations with financial indices – especially with S&P 500 – started to rise again, suggesting a reintegration of Bitcoin into the traditional financial system. Contrary to initial expectations, the results obtained from data covering 90 days before and after the launch of Bitcoin ETFs don’t show a significant increase in short-term correlations, which suggest a smooth adaptation of the market to these new financial instruments. In addition, although Bitcoin ETFs contribute to the stabilization of cryptocurrency volatility, they introduced new types of intra-day fluctuations, highlighting the need for an advanced strategy of risk management. The study concludes that, while Bitcoin ETFs contribute to the stability of financial markets, they introduce systemic risks which require continuous surveillance from the regulatory authorities. Long-term implications of the approval of Bitcoin ETFs remain uncertain, hence more research is needed in order to comprehensively assess the impact of these new financial instruments on the global financial stability.