Cryptocurrency has been touted as a hedge against macroeconomic risks and inflation. Proponents of cryptocurrency have argued that fiat currency is vulnerable to being devalued through inflation, especially when central banks “print money” to support the economy. It is common for cryptocurrencies to be designed to remain scarce as their demand increases, theoretically bolstering their value.
Throughout much of 2018 and 2019, major cryptocurrencies were able to offer both meaningful positive returns to their investors and appeared somewhat uncorrelated with broader equity markets – that is to say, it appeared possible that cryptocurrencies might deliver on their promise.
This independence not been maintained over the course of 2022 (Chart 1). From the start of the year to its trough in June, the S&P 500 fell over 20%. Despite rebounding over the summer, it is still down over 13% as of writing. Cryptocurrencies have corrected alongside equities. Since January major cryptocurrencies have fallen by over 50%.
The move higher in the correlation between equities and cryptocurrencies appears to be related to the shifting economic backdrop. Cryptocurrencies have shown lower correlations with equity markets in times of stable and high economic growth and low interest rates. But in more precarious and uncertain economic times, such as the present, they have moved in the same direction as the stock market.
The Cryptocurrency Market is Highly Concentrated and Highly Correlated
The cryptocurrency market remains highly concentrated despite the proliferation of more than 15,000 coins since the popularization of Bitcoin. Together, Bitcoin and Ethereum made up close to 60% of the market cap of the cryptocurrency universe in August 2022.
Chart 2 illustrates how much larger Bitcoin and Ethereum are compared to a selection of seven other cryptocurrencies which have been among the next largest coins for much of 2022. These are Binance Coin, Cardano, Ripple, Solana, Dogecoin, Polkadot, and Tron. The smallest of these in August 2022 is TRON, which has a market cap of around $US 500mn, compared to the roughly $US 450bn market cap of Bitcoin. The exact rankings fluctuate with the prices of cryptocurrencies, which of course are volatile. For example, TRON had almost double its 1% share of the total cryptocurrency market cap a few months ago.
Not only are Bitcoin and Ethereum the largest assets in the class, they also appear strongly correlated with the other cryptocurrencies. Chart 3 shows how the smaller players in the market all generally exhibit a high correlation with the dominant players, Bitcoin and Ethereum, using the daily returns in these markets. In other words, an investor in this market would have difficulty diversifying their risk.
Cryptocurrency Moves with Equities (More or Less)
Of most importance to investors seeking to gain protection from risks in the market is whether cryptocurrency returns are correlated with those of traditional risk assets. The basket of cryptocurrencies reviewed above have generally had a positive correlation with equity markets. Chart 4 shows that there has been strong correlation with the S&P 500, the stock index most closely linked to the U.S. business cycle. In general, the broad developed market indexes show positive correlations with cryptocurrency returns, while the correlation is very low for emerging market stock indexes.
Cryptocurrencies have also been commonly touted as a sort of “digital gold,” gold being the original safe haven asset for investors. But Chart 4 also shows that gold prices have little correlation with cryptocurrencies, and certainly far less than equities do. In 2022, so far, daily returns on gold have had close to zero correlation with the returns on major cryptocurrencies.
Of course, these correlations …….
Source: https://economics.td.com/ca-cryptocurrency-not-safe-haven