Could a single chart convince you to buy bitcoin and cryptocurrency? According to a recent article by Forbes, the answer is yes.
“One chart explains why you should own bitcoin and other cryptocurrencies,” explains Forbes in an article posted earlier today.
That chart, broadly speaking, highlights how cryptocurrency prices are unlinked to the prices of other assets in the economy. The price of bitcoin isn’t correlated to the stock market, for example, nor is to connected to the economic performance of any national government.
In other words, bitcoin could be the ultimate diversification tool for investors. It has no correlation with other assets.
Correlation is an important concept in the financial world. As Investopedia explains,
“A perfect positive correlation means that the correlation coefficient is exactly 1. This implies that as one security moves, either up or down, the other security moves in lockstep, in the same direction. A perfect negative correlation means that two assets move in opposite directions, while a zero correlation implies no relationship at all.”
The price of gold and the price of a share in a gold ETF, for example, should be almost perfectly correlated.
One of the most important rules of investing is to diversify your assets. By diversifying your assets, you can mitigate your risk. If one asset drops, then the other parts of your portfolio won’t drop with it.
Diversification is one of those things that’s easy to preach but harder to practice. It’s easy to think you’re diversified, for example, until a stock market collapse hits. When stocks drop significantly in one market, it can lead to reverberating effects worldwide. We saw this in the 1930s during the Great Depression and again in 2008 with the Great Recession. As the global economy becomes increasingly interconnected, our stock markets are becoming increasingly correlated.
Is bitcoin the “true” way to diversify your portfolio? Forbes cites new research showing just how valuable bitcoin can be to an investor’s portfolio.
Fundstrat Analysis Shows Low Correlation Between Bitcoin and Other Assets
Forbes cites a report from Fundstrat’s Alex Kern and Ken Xuan, who compared bitcoin and other cryptocurrencies to asset classes like the S&P 500, the US Dollar, international equities, US bonds, commodities, gold, and oil. Their research showed there’s a low correlation between bitcoin and other cryptocurrencies and “pretty much all of these other asset classes.”
Cryptocurrencies had single digit correlations with nearly all other asset classes, for example, which suggests there’s very little connection between the price of bitcoin and the price of other assets. Here is the chart for reference:
A National Bureau of Economic Research Report Echoes Fundstrat’s Findings
Meanwhile, a report from the National Bureau of Economic Research supports Fundstrat’s research. That paper compared bitcoin, Ripple, and Ethereum with stocks, currencies, commodities, and macroeconomic factors.
The paper, titled, “Risks and Returns of Cryptocurrencies”, establishes that the risk-return tradeoff of cryptocurrencies was distinct from those of stocks, currencies, and previous metals.
“Cryptocurrencies have no exposure to most common stock market and macroeconomic factors,” explains the paper. “They also have no exposure to the returns of currencies and commodities. In contrast, we show that the cryptocurrency returns can be predicted by factors which are specific to cryptocurrency markets.”
So what factors are correlated to bitcoin and crypto prices? Are there any indicators that are linked with the price of bitcoin and other cryptocurrencies?
The paper also concludes by stating that investors do not view bitcoin and crypto similar to other asset classes. They don’t treat bitcoin and crypto the same way they treat stocks, bonds, and commodities.
Ultimately, investors who diversify can mitigate their risk. Research suggests that bitcoin could be the ultimate diversification tool. Bitcoin isn’t tied to the performance of any stock market, nor is it tied to any national economy, fiat currency, or government decisions. Nevertheless, bitcoin investing continues to be risky in 2018, and investors are advised to do their own research.