Bitcoin, a highly decentralized and unregulated digital asset has over the years created its own path on the price curve. Over the years, some experts have associated the Bitcoin price movement to the behavior of the stock market, as it is claimed to be highly correlated to the S&P 500.
Just recently in the first quarter of 2020, the Bitcoin price was down by 10% when the S&P was down by 19%. According to trader Alex Kruger, an economist, Bitcoin continues to trade as a risk-on asset, and due to this, its next move would be determined by the stock indices.
Despite the clear sign of correlation in the recent movements, trader Scott Melker said that the common movement of Bitcoin and stock prices in the past few weeks isn’t enough evidence to classify them as correlated assets.
According to Melker, the correlation nature of assets can be accessed with -1, 0, and 1. 1 is said to be correlated when an underlying asset moves in the same direction as the other. 0 means no correlation and -1 means inversely correlated.
In March, Bitcoin had a 0.57 correlation with stocks which signifies a moderate correlation. In the last 11 years, Bitcoin had a 0.15 correlation with stocks which means there was no correlation. To conclude that Bitcoin depends on stocks to determine its price in consideration of the recent similarities in price movement is wrong.
Melker clarified that all assets including the ones recognized as “safe havens” like Silver and gold move to the direction of “1” in times of global crisis, of which Bitcoin recorded a moderate correlation of 0.57. Bitcoin by default is an uncorrelated digital asset that creates its own path. To debunk this correlation theory, he pointed out that Bitcoin bottomed on 12 March 2020, and S&P 500 bottomed on 23 March. This means when Bitcoin was rising, S&P was still falling.
The uncorrelated nature of Bitcoin makes it a portfolio diversifier. Stocks correlate to some extent as they are affected by the same factors that determine their value including company earnings, GDP and interest rate. Bitcoin, on the other hand, is affected by government regulation, network value, adoption and many more. In this case, its price can take a different direction when others are falling.
Melker believes that Bitcoin offers idiosyncratic risk rather than systematic risk. Its lack of correlation offers overall portfolio risk reduction.