Digital assets are losing their hedge advantage just as more institutional investors are entering the crypto world. In fact, allocators may be the cause.
Crypto is becoming more correlated with stocks – and it’s your fault
The correlation between the price of cryptocurrencies and the stock market has increased over time, according to a recent research study from Georgetown University. The study also found that cryptoassets followed the market’s lead even more closely during periods of high market volatility, such as the Covid pandemic and Russia’s invasion of Ukraine.
Many individual investors, market watchers and entrepreneurs have argued that cryptoassets are a safe haven given their scarcity and independence from national governments. In recent years, however, cryptocurrencies have moved in lock with shares and some critics have raised questions about whether the asset class can continue to serve as “digital gold” that protects investors in times of crisis. The new study provides further evidence that refutes the diversification benefit of crypto-assets.
The paper’s authors based their findings on an analysis of the correlation between the S&P 500 and the two largest cryptocurrencies – Bitcoin and Ether – between January 2016 and July 2022. They found that the correlation – which measures the extent to which two financial securities or instruments move together – between Bitcoin and the index were 0.08 between January 2016 and January 2021. But the correlation between the two increased to 0.33 between February 2021 and July 2022, a period of relatively high volatility. The correlation between Ether and the S&P 500 also rose from 0.04 between 2016 and 2021 to 0.38 in the most recent period. A correlation of 1 indicates that the two instruments move together.
“The recent increase in the correlation coefficient between the crypto-asset market and the S&P 500 may reflect the increased participation of institutional investors,” according to the paper.
Bitcoin and Ether have moved even more closely in line with the market when the markets are tough – just the time when investors need assets to behave differently. When the coronavirus shut down global economies in March 2020, Bitcoin and Ether recorded a correlation with the S&P 500 of 0.47 and 0.5 respectively. At the time, gold had only a 0.04 correlation with the index. From February 2022 to July 2022, as the conflict between Russia and Ukraine escalated, Bitcoin and Ether had correlations of 0.58 and 0.59 with the market, while gold had a correlation of -0.12.
The authors also compared cryptocurrencies to gold during periods of high market volatility and high policy risk. When the VIX index – a popular measure of market volatility – rose above 25, Bitcoin and Ether had a correlation with the S&P 500 of 0.43 and 0.41, respectively, while gold had a near-zero correlation with the market. The same pattern is also reflected in periods when the US Economic Policy Uncertainty Index rose above 300.
“Gold’s propensity as a hedge appears to be stronger during periods of stress, such as crypto winters, the Covid-19 shock and during higher VIX periods,” the authors concluded. “On the other hand, the correlations between Bitcoin/Ether and the S&P500 are positive and significant during these periods. This implies that Bitcoin has neither become “digital gold” nor a “safe haven” in times of crisis. Rather, Bitcoin may have acted as a risk-magnifying factor.” »
