Dispelling bitcoin risk-asset fears

Bitcoin has developed a strong correlation with risk assets, like equity, in 2020. This is an understandable concern for those who consider bitcoin a store of value – a place to secure the value of wealth over long periods of time. In this article, I dispel this concern. TLDR: the drivers of equity and stores of value can temporarily overlap, but this doesn’t imply an alteration in the fundamental characteristics of those asset classes, which are remarkably different.

Store of value can correlate with risk

To start this analysis, let’s look at gold, the traditional store of value (if you’re struggling to understand this concept, please read this article). The drivers of gold and the S&P can overlap for periods of time. Conceptually, both benefit from higher inflation expectations and more central bank liquidity. Historically, the 2-year rolling correlation between gold and the S&P has been strong on a few occasions. Despite the potential overlap in short-term drivers, the asset classes are remarkably different to each other. And through time, gold and the S&P500 always become uncorrelated again.

Highest BTC-Equity correlation on record

Turning to bitcoin, the 6-month rolling correlation on m/m returns reached its highest levels on record in 2020 so it’s definitely worth noting. The conceptual reasoning is the same as gold’s; monetary inflation and liquidity are driving strong performance in bitcoin and the S&P500 at the same time.

I’m unconvinced rising correlation is a permanent feature of these markets. 1) The strong correlation only emerged in 2020. 2) The correlation has averaged 11% historically. This is slightly higher than the long-term gold:S&P correlation of 0, but I don’t think that’s alarming. Since 2010 the gold:S&P correlation was 8.6%, so comparing like for like, there’s not much to right home about 3) I know that the asset classes are fundamentally different to each other (same logic as with gold).

Volatility to remain a defining feature

The recent rise in correlation suggests to me that BTC investors need to be very cognisant of volatility. If S&P drops, BTC will likely drop too. But volatility should already be expected by BTC investors so this isn’t really saying anything new. The higher correlation hasn’t existed for long enough for me to alter my fundamentally bullish perspective on BTC. I’d prefer to witness a lower correlation, if I had a choice, but I don’t… I’m not overly concerned by the strong correlation and I’d be surprised if it remained there for an extended period. Currently, the correlation is falling again. Let’s see how it pans out over the coming months.

I’m happy to stomach the potential volatility due to the out-sized return potential and I don’t think that BTC-equity correlation fundamentally changes anything about bitcoin.

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