Cryptocurrency: Digital Gold or Digital Equity?

By: Samiksha Rai
Abhigya Singh

This article appeared in Qrius

Whether you are an institutional investor or an indifferent Gen Z-er with no understanding of personal finance, “cryptocurrency” is one buzzword you would have found hard to avoid. What was initially regarded as a revolutionary yet outrageous concept is now looked at as the “new big thing” in finance. In fact, it is almost impossible to browse social media without encountering a headline or two on cryptocurrencies. When Elon Musk familiarized his Twitter audience with Dogecoin, it ushered in a completely new segment of the internet into the world of cryptocurrencies. In today’s age, it has almost become unacceptable to feign ignorance of the presence and strength commanded by cryptocurrencies. 

Introduction to Cryptocurrencies

A currency, in the simplest terms, is a medium of exchange for goods and services. In short, it is money, in the form of paper and coins, usually issued by a government and generally accepted at its face value as a method of payment. Cryptocurrency is decentralized digital money that is based on blockchain technology and secured by cryptography. To understand cryptocurrency, one needs to first understand three terminologies – blockchain, decentralization, and cryptography. A defining feature of cryptocurrencies is that they are generally not issued by any central authority and are run by decentralized networks. 

Let’s take a 1 dollar bill–how is it that you can buy a piece of candy with this as opposed to any other piece of paper with George Washington’s face on it? For starters, it has the Federal Reserve’s backing. The Fed maintains a detailed account of all the notes it prints. This information is also shared with the government and other banks which in turn share the details of all of their account holders with the Feds. Thus, the deposit and withdrawal of each note are carefully regulated by the banking system. Cryptocurrencies aim to break free of this centralized way of regulating money. But how is the integrity of the currency maintained? It is fairly easy to identify a fake note but how does one decipher encrypted code? This is one question that has prevented the financially prudent from venturing into the cryptocurrency market. However, securing transactions has been a key focus area for cryptocurrency developers. Cryptocurrencies are powered by blockchain networks. A blockchain is essentially a digital ledger made up of expanding blocks of data.

With a blockchain’s distributed ledger, records are kept across multiple computers on a network. Each computer is called a node, and these nodes verify and store the data. As new transactions are completed, they are added to a “block” of data, and then that block is added to the chain. The entire ledger can be updated as new transactions occur.

Fig. 1 – Key Features of Cryptocurrencies

Table 1 – Cryptocurrencies, Gold, and Fiat: A Comparison

Top Cryptocurrencies and Their Behavior

Since 2009, numerous coins have been developed and launched in the cryptocurrency space. Each coin brought about innovation and a key differentiating feature. The top 5 crypto coins according to their market capitalization–as of August 2022–and their main features, are given below. 

Fig. 2 – Top 5 Cryptocurrencies

The value of all crypto assets in circulation stood close to $996.54 billion as of August 2022. The United States M2 money supply in the same month was around $21,711 billion. Around the same time, Malaysia’s money supply was approximately $498 billion, way lower than the crypto market cap. When set against individual nations’ Gross Domestic Product, the cryptocurrency market fares extremely well. It sneaked into the top ten, wedged between France ($2.63 trillion) and Italy ($1.889 trillion) in early 2021. Thus, it is pretty evident that cryptocurrencies have become formidable enough to be paid close attention to. 

The next question, therefore, is how one can make sense of all the coins out there and whether one can draw some general conclusions on cryptocurrencies as one asset class. To determine this, we calculated the long-term correlations between Bitcoin–the largest cryptocurrency–and other major coins. Given the nature of stablecoins wherein their prices mirror the currency they are pegged against, they have been excluded from this analysis. The results are given below.

Table 2 – Correlations between BTC and ETH, LTC, ADA, and BNB

Thus, we now know that the major coins move together. So, the behavior exhibited by Bitcoin can be generalized to the cryptocurrency asset class. 

BTC and Its Correlation with Other Assets

Let’s look at some of the fundamental characteristics of Bitcoin and the way it was intended to behave. Bitcoin has a limited supply–there can only be 21 million units of BTC in total. This, coupled with its inherent decentralized nature, led many to call Bitcoin the next gold–the “digital gold” perhaps.

We calculated the long-term correlation between Bitcoin and all the major assets to see whether the “Digital Gold” title applies to Bitcoin. 

As shown in the scatter plots below, Bitcoin and Gold’s long-term correlation is quite low, whereas Bitcoin’s correlation with SPY is significantly higher.

Fig. 3 – Scatter plots Adj Close: BTC vs. Adj Close: GLD and Adj Close: SPY vs. Adj close: BTC

As shown in the table below, BTC is highly correlated with stocks (SPY, IWM, DIA, MSCI, XLK). Moreover, the highest correlation is found with XLK–the ETF comprising tech stocks. On the other hand, BTC’s correlations with gold and commodities (GLD and DBC) are much weaker. BTC isn’t as strongly correlated with bonds (TLT) either.

Table 3 – Correlations between BTC and other assets

Interestingly, on plotting 90-day correlations between Bitcoin and SPY (the S&P 500 ETF), we found that post-COVID, the correlation has been consistent and significantly stronger. Before COVID- there is no clear trend in the correlation. Although one could argue that Bitcoin’s price movement remained insignificant for a long time in the early 2010s, rendering a deceivingly low correlation pre-COVID, there are some interesting factors at play which we will discuss soon.

Fig. 4 – 90 Day Correlations SPY-BTC

The Effect of Increase in Stock Market Volatility

We looked at whether the volatility of stocks had an impact on the correlation between Bitcoin and equities. 

The VIX is sometimes referred to as a “fear index,” since it spikes during market turmoil or periods of extreme uncertainty. Generally speaking, if the VIX index is at 12 or lower, the market is considered to be in a period of low volatility. On the other hand, high volatility is often seen as anything that is above 20. When you see the VIX above 30, that’s sometimes viewed as an indication that markets are very unsettled.

Our analysis concludes that during periods of high volatility, the correlation between SPY and BTC is stronger. The following table summarizes that the higher the volatility in the stock market, the higher the correlation between SPY and BTC.

Fig. 5 – Impact of volatility on correlations between SPY and BTC

As is clearly demonstrated, as VIX increases beyond 20, SPY and BTC become increasingly correlated. It is interesting to note that when VIX is below 10, the correlation between SPY and BTC is higher than when VIX is between 10-20.  An explanation to this phenomenon is that when VIX is low and the market is doing well, there is increased liquidity, leading both SPY and BTC to swell. On the other hand, when the market is highly volatile, the “fear factor” affects both SPY and BTC in a similar manner. 

Further strengthening our analysis is the Moving Averages chart of SPY-BTC correlations vis-vis VIX values:


Fig. 6 – Moving Avergae of SPY-BTC Correlations vs VIX

conclude, periods of fear, and perhaps tranquility too, are when stocks and cryptocurrencies move together. When VIX is in its normal range, that is when one expects assets to be fairly valued, and that is exactly when SPY and BTC have a negative correlation value. The SPY-BTC correlation is then probably only driven by extreme market conditions?

Decoding the Coupling and Decoupling of Stocks and Cryptocurrencies

When two assets become coupled, their price movements are usually correlated with one another. We have already established that S&P 500 and Bitcoin have been moving together since the onset of COVID-19.

As the name suggests, decoupling means the dissociation of two different elements. Decoupling occurs when the S&P 500 and Bitcoin move in a separate direction, independent of one another.

Coming back to the question of increase in SPY-BTC correlation post COVID- the change in the decade-long behavior of low correlation can be attributed to the rapid change in technological needs because of the pandemic. Money has become increasingly digital in the post-pandemic world. Interestingly, post-2020, Bitcoin trading volume has increased significantly, and cryptocurrencies have begun entering mainstream finance. 

However, experts suggest that people are trading cryptos the only way they know how- the same way the asset classes they are most familiar with are traded. Most people still treat Bitcoin as a high-risk stock, i.e. they see both stocks and crypto as similar “risk-on” assets. This is supported by the fact that the more uncertainty there is in the market from factors such as continuing COVID-19 surges, inflation and interest rate hikes, the higher the correlation is between stocks and Bitcoin.

Possible decoupling is when the adoption of cryptos grows, and it is viewed as a separate asset class and not an extension of the stock market. Our volatility analysis also concludes that the decoupling between SPY and BTC, if that happens, will certainly not occur in a period of extremely high or low volatility.  

Another scenario in which crypto gets decoupled from traditional indices is when investors lose faith in one of the two asset classes at that time. Diminished investor confidence can stem from multiple causes such as geopolitical tension, regulatory clampdowns or new legislation, economic performance, etc. For example, experts believe that the brief decoupling at the end of May 2022 happened due to the Terra fiasco. Technology stock investors, who had also been trading crypto as a speculative asset, paused their activity in the space, as the collapse of Terra shook their confidence in the digital asset market. 

On the other hand, there are some who believe that cryptos and stocks might never decouple. Shark Tank star and investor Kevin O’Leary ultimately expects cryptocurrencies to become a sector of the stock market and be completely integrated within it. 

Implications for Investors

Now that we know Bitcoin behaves like equities during periods of abnormal volatility, what does it mean for investors? 

Be prepared for the correlation between stocks and cryptocurrencies to continue at least till the stock market volatility is high. 

Since we now know of the relationship between Bitcoin’s movement and the stock market’s volatility, one can utilize this to take positions in the cryptocurrency market. As of June 2022, both BTC and SPY prices have been on a downward trend. If volatility remains high amidst uncertain macroeconomic conditions, it would be fruitless to use cryptocurrencies as hedging assets for now.

Is the case for “Digital Gold” closed?

Given the original purpose of Bitcoin, it is important to determine if Bitcoin will ever start behaving like gold. For this, it is essential to first understand why Bitcoin is not a hedging instrument just yet. Owing to the fact that Bitcoin is an unregulated asset, there is a lot of uncertainty regarding its usage outside the blockchain universe. Although an increasing number of corporations–and even governments–have acknowledged the utility of cryptocurrencies, it is nowhere close to gold in terms of its regulatory backup and investors’ confidence. Apart from this inherent risk, the prices of cryptocurrencies are also highly dependent on speculations which further discourages investors who are looking for a fairly stable hedging instrument. However, one cannot fully close the case for digital gold just yet. Even after the crypto- winter of 2018–when prices dropped by almost 70%–and several other such market slowdowns, the crypto-market showed steady recoveries. More institutional investors are now talking about their investments in cryptocurrencies than ever before. With more widespread recognition of cryptocurrencies, one can expect investors’ confidence to pick up and the associated volatility to dip–paving the way for digital gold. 

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