Today I embarked on a task to find some sort of correlation between Bitcoin and other financial assets.
Before doing this we had to define which asset class Bitcoin belongs too.
Bitcoin can be classified as a store of value asset.
Store of value assets do not generate income, you cannot consume it and yet it has financial value.
The most common store of value assets in modern times has been money, currency, a commodity like a precious metal or in our case a cryptocurrency.
Store of value assets is often referred to by other names, including “safe haven assets” and “flight to safety assets”.
Thus, we should expect that Bitcoin should have a higher correlation to other store of value assets.
This being said I created a correlation matrix using Bitcoin, major currency pairs and gold.
Correlations are measured on a scale between 1 and -1.
The closer the correlation is to 1, the pair is then positively correlated and move in the same direction.
The closer the correlation is to -1; the pair is negatively correlated and moves in opposite directions.
The analysis above shows that there is a very low correlation between Bitcoin and other financial assets in its class, thus making Bitcoin a unique asset that is not affected by regular macroeconomic conditions.
There is evidence that Bitcoin serves as a hedge during major or disastrous geopolitical events, as spikes in price were witnessed during Brexit and the Trump election.
The much anticipated Segwit upgrade is due for activation by the end of August to mid-September and some analysts are saying that this could push the price up by $2000.
Conversely, Donald Trump has just signed a controversial foreign sanctions bill that included a section on cryptocurrencies. There is no knowing right now how this will affect the price of cryptocurrencies but it is definitely something worth keeping an eye.
Lastly, being a digital currency there are underlying technological aspects that one needs to keep in mind, as these can adversely affect the cryptocurrency price and reduce demand.
- Scaling Challenges
- Increase in transaction costs
- Time-consuming transactions
- Block size limitations
In summary, Bitcoin is an excellent candidate to be added to a passive long-only portfolio as it’s uniquely positioned to serve as hedge against major geopolitical risk and at the same time not affected by regular macroeconomic events. However, use the technicals to try and find a discounted entry position.