Crypto’s diversification benefits questioned

In times of crisis, there is substantial correlation with equities, study finds

Crypto’s diversification benefits questioned

As more institutional investors enter the cryptocurrency market, digital assets are starting to lose their hedging advantage.

A new study from Georgetown University found that over time, there has been a growing association between the value of cryptocurrencies and the stock market. During times of extreme market volatility, such as the Covid epidemic and Russia's invasion of Ukraine, the study also discovered that crypto assets closely followed the market's trend.

Due to its rarity and decentralized nature, many individual investors, market observers, and businesspeople have suggested that cryptocurrencies constitute a safe refuge for capital. Though some opponents have questioned whether the asset class can continue to act as "digital gold" that shields investors during crises, cryptocurrencies have recently been advancing in lockstep with equities.

The latest study refutes the diversification advantage of crypto assets, with conclusions based on an examination of the link between the S&P 500 and the two most popular cryptocurrencies, Bitcoin and Ether, between January 2016 and July 2022. The researchers discovered that between January 2016 and January 2021, Bitcoin and the index had a correlation of 0.08, which assesses how closely two financial securities or products move together.

However, during the very volatile period from February 2021 to July 2022, the correlation between the two grew to 0.33. Ether and the S&P 500's connection increased as well, from 0.04 to 0.38 between 2016 and 2021. The two instruments move in tandem when their correlation is 1.

“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.

When markets are unstable—exactly the period when investors need assets to behave differently—Bitcoin and Ether have moved even more closely in accordance with the market.

Correlations between Bitcoin and Ether and the S&P 500 were 0.47 and 0.5, respectively, when the coronavirus crippled the world's economy in March 2020.

Gold's correlation with the index at the time was merely 0.04. As the crisis between Russia and Ukraine intensified from February to July 2022, Bitcoin and Ether's market correlations were 0.58 and 0.59, compared to gold's -0.12 correlation.

In times of severe market volatility and substantial policy risk, the authors also compared cryptocurrencies with gold. Bitcoin and Ether had correlations with the S&P 500 of 0.43 and 0.41, respectively, whereas gold had a connection with the market of almost zero when the VIX index, a common indicator of market volatility, soared over 25. The similar pattern is also seen when the United States is not present. Indicator of Economic Policy Uncertainty increased above 300.

Gold’s propensity as a hedging asset appears to be stronger during stressed periods, such as crypto winter, the Covid-19 shock, and during higher VIX periods,” the authors concluded.