About Those Crypto Correlations

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@dave-balterDave Balter

CEO of Flipside Crypto

Does Bitcoin Zig When the Stock Market Zags?

One of the major selling points for investing in cryptocurrencies has been the lack of correlation to most other asset classes. Nearly 10 years after the creation of Bitcoin, is this still the case?

There are many factors bitcoin investors focus on when analyzing the cryptocurrency, but its price, volatility and correlation to other asset classes are usually at the top of the list.

While the price and volatility of bitcoin get A LOT of press, the topic of correlation doesn’t get all the attention it deserves. This is especially true considering that correlation analysis is becoming increasingly important for investors using crypto assets to diversify their overall portfolio holdings.

Correlation is something we’ve been thinking about since day one and, frankly are a key factor in developing effective baskets. So, it’s important to take a step back and look at what we currently know about crypto correlations. Maybe more importantly — and what don’t know.

Correlating Which Correlation

First, it’s important to remember there are two main types of correlations to consider with cryptocurrencies:

  • the correlation among cryptocurrencies (e.g., how the price of BTC moves relative to ETH) and;
  • the correlations between crypto assets and traditional assets (e.g., how the price of BTC moves relative to the S&P 500).

There is certainly a lot to cover regarding the correlations among BTC, ETH and other crypto assets, but for now let’s focus on correlations between crypto and traditional asset classes.

Understanding how the prices of bitcoin and other cryptocurrencies move relative to stocks, bonds, and commodities is certainly a developing and uncertain space, but we do believe there are ways for investors to think about correlation that can help them better understand where all of this may be going.

Digital Safe Haven

In bitcoin’s early days, many people argued this new digital currency would be the perfect “safe haven” asset, an uncorrelated alternative not as impacted by the macroeconomic factors that influence more traditional asset classes. Buying bitcoin for the long-term, many people said, will ensure you’ll own an asset minimally correlated to the highs and lows of the stock market.

But does this still hold true?

The answer, of course, is not entirely black and white. While bitcoin and other cryptocurrencies remain far less correlated to the stocks, commodities and even currencies, there have been recent instances where correlations have increased, making many people wonder if bitcoin is truly the hedge or safe haven store of value it was sold as back in its early days.

For some recent perspective, let’s take a closer look at some of the available data on bitcoin’s correlation to other markets.

Earlier this year, a report from JPMorgan analyzed correlations form the perspective of overall portfolio diversification. Essentially, using modern portfolio theory they considered cryptocurrencies as they would any other asset class, evaluating how crypto assets would impact a portfolio’s risk-return characteristics.

In addition to finding that crypto volatility is significantly higher than equities or commodities, something we are all well aware of, the analysts found that

while it’s unclear how crypto assets would perform during periods of extreme market stresses, they could provide diversification benefits in part because of their extremely low correlation to global equities and bonds.

They found that over the last five years bitcoin’s correlation to the S&P 500, US Treasuries, gold and other commodities was almost zero. In other words …Portfolio efficiency could be improved with the addition of cryptocurrencies.

More recently, others have observed that correlations between crypto and traditional assets have been ticking upwards. While this does seem to be the case, these correlations are still extremely low compared to other markets.

In a May report, Bitwise Asset Management found that bitcoin’s correlation to stocks and bonds was 0.12 and 0.25, respectively (1.0 being perfect correlation). Not as close to zero as they had been, but still very low. As a comparison, Bitwise highlights a correlation between US and international equities of 0.88 over the same period.

Sifr Data tracks correlations for cryptocurrencies, and as of July 18th the 90-day correlation between BTC and the S&P 500, -0.27, shows a continued weak relationship between the cryptocurrency and the stock market, while BTC’s -0.1 correlation with the gold market demonstrates the same lack of correlation.

Sifr Data Crypto Correlation Matrix

These low correlations are due to different drivers of returns in the crypto markets (e.g., investor adoption, legal and regulatory developments) versus the stock and bond markets, which are driven more by factors like economic growth, interest rates and corporate profits.

It’s possible that as bitcoin gets more popular, and more people invest–particularly institutional investors–it will become increasingly correlated with traditional markets.

How correlated will depend on many factors, including those listed above, but it will continue to take time to understand how this emerging asset class will best fit into broader portfolios.

Some Things Stay the Same

While correlations between crypto assets and the other asset classes remain low, one thing is consistently true: Just like with stocks, cryptocurrencies can be overhyped and overpriced. The noise around some crypto assets (here’s looking at you ICOs) doesn’t mean, however, that they should be dismissed as overly risky or unsustainable investments.

Because of the current small size of the crypto markets, it will continue to be challenging to decipher correlation trends between the crypto markets and other more developed markets.

But there are real life applications for this emerging asset class that investors shouldn’t ignore, and its current lack of correlation to other markets may be one of the best.

While there are no silver bullets and (just like with any other type of investing), risk is always present. And tooday, cryptoassets can absolutely serve as a great diversification benefit in an investor’s portfolio.

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