Correlations may be sufficient to produce narratives, but for how long will they remain valid? We find out here.
Bitcoin keeps stealing headlines every time its price reaches a high enough correlation with another asset. Bitcoin remains notoriously difficult to predict due to its numerous and inherent peculiarities. Nonetheless, can we glean useful insight from these sporadic correlations or do we simply tell ourselves stories as pattern-seeking beings?
Which Factors Drive Bitcoin’s Upward Trajectory?
Aside from the anomalous March crash, if we view Bitcoin from a zoomed-out perspective, its market cap rise for the last year can be attributed to the following factors well-established in the crypto space:
- Greater network effect as a result of an increased number of users and network nodes.
- Increased adoption rate, due to multiple reasons: stimulus checks, inflation fears because of the Fed’s money-printing, diversifying traditional portfolios.
- Less common crypto exchange hacks and to a lesser degree. Thus, reduced negative publicity and sell-offs.
- Halvings driving up the demand, which happened with two halvings so far.
Altogether, these long-term factors push Bitcoin’s price upward into the next bull period. The tricky part is then to determine the forces that drive Bitcoin’s price during the much longer consolidation periods. During such times, Bitcoin’s price intertwines with other assets. Recently, it happened with S&P 500:
If we take a look at the chart of BTC to S&P 500 correlation, it is rather weak and inconsistent. In short, BTC behaves like a risk asset that it still is – with high volatility. At other times, BTC correlates with other assets, like gold.
It’s safe to say that during these consolidation periods Bitcoin does exhibit the traits of gold. Having a much longer history than Bitcoin, we know that gold slumps when real interest rates rise, which represents interest rates adjusted for inflation. This happened during the 20-year period between 1980 and 2020, as the chart below shows.
Gold is similar to BTC, but only in the sense that gold represents a scarcity asset. Otherwise, it doesn’t produce yields and instead incurs storage and handling costs. In other words, if we see a relatively high correlation between gold and BTC, does that tell us anything important?
The Perplexing Nature of Bitcoin
Haphazard correlations between BTC and other assets point in the direction of what we already know. Bitcoin is an asset uniquely difficult to measure due to its unique properties:
- It has some gold properties.
- It has some cash properties.
- It is as speculative as equities.
- It is perceived as a bulwark against inflation or even dollar collapse.
- It serves as an additional portfolio diversification asset, driving institutional and momentum investors.
- It has a high status-signaling value, derived from a particular philosophical ecosystem and driven community.
Given the wide scope of Bitcoin’s properties and its tendency to correlate with other assets during the periods of consolidation, it stands to reason that different short-term factors would determine the direction of these correlations.
Depending on the news of stimulus packages, the real rate of inflation, irrational market exuberance, and economic factors that influence other assets, so too Bitcoin may end up syncing with those assets. Furthermore, this is made even more complex with the steadily rising trend of HODLers – people who have seemingly decided that Bitcoin represents a safe haven on the same level as gold.
This alone is likely to affect other investors. In the end, we have an inkling that the stock market is on life support by the Federal Reserve. Bitcoin crashed just as hard and rallied just as much, but Bitcoin is a divergent enough asset to render such extrapolation moot. Especially now, when people can no longer be discombobulated as easily by the devastating, lockdown-derived harm.
Originally Posted on October 13, 2020 – Bitcoin’s Value Isn’t Really Correlated to Gold – Here’s Why
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