Original title: “Depth丨The correlation is negative, BTC has become a safe-haven asset? 》
Written by: Sacha Ghebali
Translation: Edward
Looking back at 2020, there are many theories about the relationship between cryptocurrencies and major asset classes. This article outlines the market correlation and volatility of major cryptocurrencies (BTC and ETH) and traditional asset classes (stocks, foreign exchange, and precious metals) from the beginning of the year in order to better understand market trends and risk management.
In the financial sector, risk is usually measured by volatility, which indicates the magnitude of price changes. The greater the risk, the greater the volatility, and the greater the chance of winning or losing large sums of money. In the field of modern finance, investors should be compensated for risks that cannot be diversified: the greater the risk they take, the greater the return they should receive. However, in times of crisis, this relationship often reverses, and investors may face huge risks without corresponding returns.
In addition to the volatility of a single asset itself, another cornerstone of the risk puzzle (the core of asset allocation) is the mutual change between assets, or in other words, the correlation coefficient between them. Without involving random matrices and other mysterious mathematical concepts, the estimation of these correlations does bring challenges, and in this era of high volatility and irregularity, these challenges become more severe.
Therefore, estimating the volatility and correlation between cryptocurrencies and other asset classes often leads to confusion and contradictory interpretations . There are many methods, all with advantages and limitations, but it is still difficult to explain. As CoinDesk Research Director Noelle Acheson accurately described on September 1st:
Did you know that it seems that the correlation between BTC and TSLA is increasing! BTC is now more correlated with TSLA than with the S&P 500 index. This must mean,
It is now considered a technology stock. No wait, it is seen as a representative of market hype. No, wait, I mean it is seen as a moon. Short-term correlations can tell a good story, but they are meaningless.
This article introduces a calculation method based on the so-called exponential moving average to paint a stronger picture of volatility and correlation in 2020. The main advantage of this method is that it has more weight on recent events than on old events, thereby preventing irregular events from the distant past from disproportionately affecting the current value. The results shown in this article use the RiskMetrics Group method with an attenuation coefficient of 0.94.
The asset classes represented in this analysis are: a) encrypted assets BTC and ETH, b) stocks (S&P 500), c) foreign exchange market, and d) precious metals (gold).
Without any suspense, let’s take a look at how the correlation between these assets has evolved since January 2020. Figure 1 shows the correlation of ETH, S&P 500 Index, DXY, and the price of gold (XAU) relative to Bitcoin. A correlation of 1 means that the asset and the price of BTC move synchronously, while a correlation of -1 means the opposite. Please note that the famous BTC “hedging” term implies low or negative correlation with the market, which has not always been the case in history.
Figure 1: Correlation between BTC and other assets
On March 12, after the market plummeted due to the COVID-19 pandemic, there was a sudden rise in correlation. Although the DXY (dollar index) reversed soon after, the huge correlation between the S&P 500 index and BTC continued for a long time. Until recently, as more and more investors announced the massive allocation of digital assets, BTC was rising rapidly at an unprecedented price, and this correlation began to weaken.
Historically, the correlation between ETH and BTC this year is very high, especially from March to August. Starting from the summer, the correlation fluctuation between these two assets is likely to be a response to the DeFi boom and the intense activities and uncertainties associated with the transition of Ethereum 2.0. In the weeks before the launch of the Beacon Chain on December 1, the correlation between ETH and BTC reached its lowest point of 0.14 on November 24.
Next, compare the historical volatility of the same asset on Figure 2. It can be seen that although the volatility has declined since the market crash in March, the volatility of the S&P 500 index is still higher than the levels in January and February.
Figure 2: Volatility of major crypto assets (BTC/USD and ETH/USD exchange rates), market returns (S&P 500 index), USD index (DXY) and gold (XAU)
By comparing with the volatility of BTC, Figure 3 shows the ratio of BTC to the historical volatility of each asset. For example, the value of the ratio is 2, which means that the volatility of BTC is twice that of the corresponding asset. Before the March crash, due to rising uncertainty, Bitcoin’s volatility relative to traditional asset classes became smaller. However, the “Crypto Black Thursday” on March 12 showed a weaker rebound, followed by a liquidation spiral. The rise in volatility leads to soaring volatility, causing the price of Bitcoin to reach a bad level.
Figure 3: Volatility relative to Bitcoin. For example, a volatility of 2 means that Bitcoin’s volatility is greater than 2 times
Conclusion
In 2020, the correlation between major asset classes and BTC follows a different pattern. It is worth noting that its correlation with the stock market (S&P 500 Index) continued to rise to a relatively high level, while its correlation with gold (XAU) remained low throughout the year.
The volatility of BTC and the S&P 500 index in 2020 is at a historically low level, and the two are almost the same from early March to mid-March. Due to the impact of this bull market, the volatility of the crypto market has seen a new surge since November. From the plunge in March to the beginning of the DeFi summer explosion, BTC and ETH are highly correlated. However, this behavior has changed. As the first phase of the transition to Ethereum 2.0 is approaching, there has been a short and strong decoupling. It will be interesting to follow this relationship, especially as more investment flows into the field of digital assets, the transaction volume on the ETH market increases, and institutional derivatives products are also seeing the light (CME announced the ETH futures in February 2021) .
2020 will end with the extremely promising prospects of Bitcoin and crypto finance. As more and more institutional funds enter the field, as a means of diversifying investment and hedging economic uncertainty, one of the major cryptocurrency and stock markets The correlation between has entered a low to negative value.
