Hype of the Week: How Correlated is Bitcoin?
Bitcoin has been touted as “the” safe-haven asset, uncorrelated from the lechery of the traditional financial market. This week, Bitcoin’s uncorrelation has again been brought up by Bitcoin evangelist’s, but what do they mean? With all this talk about correlation and safe-haven assets, let’s look into Bitcoin’s asset correlation and safe-haven status.
Asset Correlation determines the extent to which two or more assets are dependent on one another. By determining a correlation between assets, investors can observe the direction and magnitude of a relation between assets and can construct portfolio’s that minimize their market risk.
The scale of the correlation coefficient ranges between 1 and -1, with 1 indicating perfect positive correlation and -1 indicating perfect negative correlation. If assets are perfectly uncorrelated, the coefficient is 0. When assets are positively correlated, they move in the same direction with one another, if they are negatively correlated, they have an inverse relationship.
Since its inception, Bitcoin has been heralded as the new safe-haven asset; possessing properties such as being a store of value, hedge against inflation, easy to liquidate and unaffected by monetary policy. Thus, Bitcoin should retain or even increase in value during periods of economic volatility and market downturns. For this to be the case, a negative or a complete lack of correlation would have to be apparent. Conversely, if a positive correlation emerged it would signify that Bitcoin is no different than any other alternative asset in the market.
Over the past years, Bitcoin’s correlation has been moving from a positive to a negative correlation as the market matures. Most recently, metrics have shown that moderate positive correlation has dropped back down to 0, as shown by Santiment’s correlation data.
Santiment’s figures reflect the conclusion reached by Fidelity at the start of the month. Fidelity published a widely read report indicating that Bitcoin showed very weak positive correlation with the returns of other assets. The average correlation was 0.11.
Although recently published information may seem to indicate that Bitcoin truly is an uncorrelated safe-haven asset, the evidence for this when it mattered was bleak.
During the COVID market crash of March correlation between Bitcoin the S&P500 and all other assets was strongly positive. Many ,at the time, were claiming that Bitcoin was as fallible to crisis as any other asset.
Although many have used the pandemic to demonstrate that Bitcoin is correlated to other traditional assets and markets, gold, the original safe-haven asset dropped during the COVID market crash as well. The reason for this is that the market crash for Bitcoin and gold was the result of a liquidity crisis.
During a liquidity crisis, cash is king and all types of assets that are easy to liquidate are sold for cash. Many investors are highly price insensitive and will do whatever they can to dampen their loses by increasing their cash on hand.
Jury Still Out
The answer as to whether Bitcoin is the safe-haven asset, uncorrelated from the rest of the market, is not entirely clear. Many assets in their early days show a lack of correlation due to high volatility and fragile market structure. Although Bitcoin is over a decade old, it is still a young market and is considerably volatile. As the market grows more mature, volatility will decline and Bitcoin’s correlation profile may very well become more correlated.
However, simply dismissing Bitcoin’s safe-haven status on the premises of the market crash during COVID may well be a case of jumping the gun. Particularly, when Bitcoin has been beating the market in a year shrouded in economic and political uncertainty.
Author: Stephan Eduard Pàl Roth