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As 2021 is about to enter the rearview mirror, now is a good time to reassess the notion that cryptocurrency is still a risky asset class. After all, the risks of encryption will help determine how to allocate assets in 2022.
For many traders, the massive sell-off in March 2020 is still a memory, whether it is pain or profit. Bitcoin and Ethereum, as well as almost all cryptocurrencies, plummeted, as if they were tied to falling stock and bond yields at the time. Around that time, we began to hear people say that encryption is a risky bet, which means that it performs well when investors feel risky, and it performs poorly when they feel upset.
It may be risky because it is a bet on the future of finance; if money is to be transferred to the blockchain, owning blockchain money is a reasonable way to play.
Of course, here is where to insert an obvious chart: a chart showing a series of correlations.
The black line shows the correlation between Bitcoin and the S&P 500 index, which represents the US stock market. If stocks are usually a risk bet (compared to bonds), then people will assume that Bitcoin will be highly correlated with the index, or at least will move in this direction.
Except, um…no, it’s not. When it peaked two months ago, the 90-day correlation coefficient between Bitcoin and the S&P 500 peaked at around 0.31. That is quite weak. At the lowest point in June 2021, the coefficient was -0.04, which means that there is no statistical relationship between US stock prices and Bitcoin.
Therefore, people will draw a red line to show the correlation between Bitcoin and gold. Given the limited supply of 21 million coins of this cryptocurrency, it should serve as an inflation hedge in a world where the Federal Reserve and the U.S. government come up with new ways to flood the market.
There are no dice either. The 90-day correlation between Bitcoin and gold reached its peak in 2021 at the beginning of January, which was also 0.30. Since then, it has been tumbling around the 0 line in vain like a fish, and then hit its head on the deck. Its lowest point is -0.18 in August, which is only a poor 0.07. Gold and Bitcoin are not traded together.
Annoyingly, someone proposed the last one: the correlation between Bitcoin and bonds, represented by the iShares 20+ year Treasury Bond ETF (TLT, yellow). If cryptocurrency is not traded with stocks or gold, of course, it is very tight with bond trading, right? Incorrect. Compared with others, the line insists on 0, just like Seth Rogen insists on a bad script. This also applies to commodities (e.g. iShares S&P GSCI Commodity-Indexed Trust is shown in green).
There are several reasons why Bitcoin is not related to these major macro assets. Some of them are related to its value proposition. Another possibility is that the crypto market is still in its infancy and is therefore driven by a small number of major players, whether people are willing to admit it or not.
The benefit of a portfolio manager is that the low correlation with other asset classes makes crypto the least that the portfolio must consider in order to promote diversification.
The downside is that non-stable currency encryption-even its “most secure” cryptocurrency-Bitcoin-is very unstable.
Despite this, Chen LI, CEO of venture capital firm Youbit Capital, said that the view that Bitcoin is related to other risky assets or gold still exists, but what happens in the next few quarters will test this argument. He expects risky assets to increase interest rates as the Fed gradually scales back its bond purchase program (bond yields rise when bond prices fall, which is expected because the central bank will not buy as much in the market as usual).
“We will see if Bitcoin can withstand gravity,” Li told CoinDesk’s Forerunner Program on Thursday.
Li believes that the breakdown of the correlation is not between macro assets and Bitcoin, but between Bitcoin and other cryptocurrencies.
The 90-day correlation coefficient between Bitcoin and Ether is at a very high 0.80, although Ether defeated Bitcoin’s return in 2021, as did many others.
However, the correlation coefficients of the native tokens of Ethereum’s competitors are slightly lower. Li believes that as other smart contract platforms become more adopted, these correlations will decrease. He also saw another influencing factor, which may not be so intuitive: the way assets are traded.
“In the centralized and local [decentralized exchanges] We see more trading volume of stablecoin pairs than BTC or Ethereum pairs,” Li said. “Because… the correlation between alternative tokens and stablecoin transactions, Ethereum [or] Bitcoin has just fallen. “
Li said that if one cryptocurrency is priced primarily for another cryptocurrency (such as Bitcoin), they will move together. He added that trading with stablecoins, which are usually pegged to the U.S. dollar, breaks the link between these currencies and currencies such as Bitcoin and Ethereum.
Perhaps 2022 will be a year when altcoins and Bitcoin are more irrelevant, and Bitcoin is irrelevant to macro assets. In this case, we may see a world where traditional portfolio managers will have to give substitutes once in a minimal way, just to have a diversified portfolio.
That should be interesting.
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