Part of the appeal of Bitcoin and other cryptocurrencies is the lack of correlation to mainstream asset classes; however, a new report from Bloomberg suggests this characteristic might actually be constituting a headache for traders and investors alike.
Bitcoin Shares Little Relationship with the Mainstream Market
Some experts believe that crypto enthusiasts are mistaking non-correlation for inverse correlation. Despite the emergence of a currency crisis in some countries, the effect on the virtual currency market has been minimal. Thus, the assumption that the value of digital coins will grow during periods of distress in the mainstream market has proven to be demonstrably fallacious.
Commenting on the matter to Bloomberg, Matt Hougan, the Bitwise Asset Management Vice President of Research and Development, said:
“Non-correlation is not the same as inverse correlation so there’s no guarantee that when the market goes down crypto will go up. Over the long term, we think the fundamental drivers of crypto are different from the fundamental driver of equities and other assets, and we would expect the low correlation to persist.”
Recent studies have reinforced the notion that Bitcoin isn’t correlated to the mainstream market. Using a scale between 1 and -1 where the former represents a strong positive correlation and the latter, a strong negative correlation, Bitcoin rarely moves above 0.5. This means that the price trajectory of the top-ranked cryptocurrency has little to do with conditions in the mainstream asset market.
Suggested Reading: Learn more about Bitcoin in our ‘What is Bitcoin?‘ beginner’s guide.
Cryptocurrency Investors Should Worry About Portfolio Diversification
During the price boom of 2017, digital coins were hailed as a practical asset class for portfolio diversification. The lack of correlation to the forex market, the stock market, etc., meant that investors could hedge against the possibility of market crashes by holding virtual coins as part of their portfolio.
While this approach might work for investors who hold both crypto and non-crypto assets, cryptocurrency-focused investors are at a disadvantage. Why? Because the rest of the cryptocurrency market shares close correlation to Bitcoin. BTC holds an almost 70 percent correlation to the altcoin market. This means that price movements in BTC will directly affect the other 1,600+ altcoins.
Until a decoupling occurs and discrete coins begin to dance to their respective market tunes, holding multiple cryptocurrencies doesn’t equate to a diversified portfolio.
Suggested Reading: For an example of a non-diversified portfolio going awry, read about an Abu Dhabi resident who is $163,000 in debt after his altcoin portfolio sunk by more than 85 percent.
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