Why Portfolio Managers Will Have to Have a look at Altcoins in 2022
With 2021 in the rearview mirror right now, it’s a good time to reconsider the notion that cryptocurrencies are still a risky asset class. Ultimately, the risk posed by crypto will help determine the asset allocation in 2022.
For many traders, the massive March 2020 sell-off is still a memory, be it one of great pain or profit. Bitcoin and ether, as well as pretty much every cryptocurrency, took a nosedive, as if they were chained to falling stock and bond yields back then. It was around this time that we heard the refrain that crypto is a risky bet, meaning it does well when investors are adventurous and bad when they get nervous.
And it can be risky as it is a bet on the future of finances; With money flowing into the blockchain, owning the blockchain’s money is a reasonable way to play it.
Of course, one adds an obvious graph here: one that shows a stack of correlations.
The black line shows the correlation between Bitcoin and the S&P 500, the index that represents the US stock market. In general, if stocks were a risky bet (compared to bonds), one would assume that Bitcoin is highly correlated to the index, or at least moving in that direction.
Except, well … no, it isn’t. At its peak two months ago, the 90-day correlation coefficient between Bitcoin and the S&P 500 peaked at around 0.31. That’s pretty weak. At its low point in June 2021, the coefficient was -0.04, meaning that there was no statistical relationship between the prices of US stocks and Bitcoin.
So you also throw in a red line that shows the correlation of Bitcoin with gold. Given the cryptocurrency’s limited supply of 21 million coins, it should serve as an inflation hedge in a world where the Federal Reserve and the U.S. government are considering new ways to flood the market.
No dice either. The 90-day correlation between Bitcoin and gold peaked in early January 2021, also at 0.30. Since then he has been fluttering around the 0-line like a fish in vain before he is hit in the head on deck. Its lowest point was -0.18 in August and it’s a measly 0.07. Gold and Bitcoin are not traded together.
Annoyed, one throws one last line: the correlation of Bitcoin with bonds, represented by the iShares 20+ Year Treasury Bond ETF (TLT, in yellow). If the cryptocurrency isn’t trading stocks or gold, it is certainly closely related to bonds, right? Not correct. Compared to the others, this line sticks to 0, just as Seth Rogen sticks to bad scripts. This also applies to commodities (as shown in green by the iShares S&P GSCI Commodity-Indexed Trust).
There are several reasons why Bitcoin does not correlate with these important macro assets. Some of this has to do with its value proposition. Another could be because crypto markets are still in their infancy and therefore being pushed around by a handful of big players whether people like to acknowledge it or not.
The benefit to a portfolio manager is that its low correlation with other asset classes makes crypto something that needs to be considered at least for a portfolio in order to encourage diversification.
The downside is that unstable cryptocurrencies – even their “safest”, Bitcoin – are terribly volatile.
The perception that Bitcoin is correlated to other risky assets or gold remains, however, but what happens over the next few quarters will test that thesis, according to Chen LI, CEO of venture company Youbit Capital. He expects risky assets to fall when rates rise as the Fed cuts its bond-buying program (bond yields rise when bond prices fall, which is expected since the central bank won’t be that much in the market to buy) . like in old times).
“We’ll see if Bitcoin can withstand gravity,” Li told CoinDesk’s first mover program on Thursday.
Where Li sees the breakdown of correlations is not between macro assets and, say, Bitcoin, but between Bitcoin and other cryptocurrencies.
Between Bitcoin and Ether, the 90-day correlation coefficient stands at a very high 0.80, even though Ether, like many others, outperformed Bitcoin’s returns in 2021.
However, the correlation coefficients for the native tokens of the Ethereum competitors are slightly lower. Li believes that these correlations will decrease as other smart contract platforms gain acceptance. And he sees another factor that may not be as intuitive: it’s the way the assets are traded.
“In centralized and dexes [decentralized exchanges] We’re seeing more volume in the stablecoin pairs instead of the BTC or Ethereum pairs, “Li said.” Because … alternative tokens are traded for stablecoins, the correlation is between Ethereum [or] Bitcoin just fell. “
If a cryptocurrency is valued primarily against another cryptocurrency like bitcoin, they will simply move closer together, Li said. Trades against stablecoins, which are often pegged to the US dollar, break those currencies’ ties to bitcoin and ether, he added.
Perhaps 2022 will be the year that altcoins will be less correlated with Bitcoin, which in turn will not correlate with macro assets. In that case, we could see a world where traditional portfolio managers only need to rethink the alternatives just to have a diversified portfolio.
That should be interesting.