Bitcoin may decouple from stocks one day, but it hasn’t happened yet
- Debate is fervent over whether Bitcoin will one day become an uncorrelated hedge asset
- For the time being, however, Bitcoin trades like a high-risk asset
- Last year demonstrated this clearly, the first wider economy bear market of Bitcoin's short existence
“Can Bitcoin ever become an uncorrelated hedge asset, like some kind of digital version of gold?”
There is perhaps no question I see more often from clients and investors alike. And personally, I would argue it is among the most fascinating in all of crypto.
It’s a riddle that I have done a lot of work on. I’ve built dozens of models, constructed all kinds of simulations, and, frankly, spent far too much time working on a question that simply can’t yet be answered with certainty (lockdowns were a nice excuse, but it’s now becoming harder to justify staying indoors on a laptop for 22 hours a day).
We can theorise all we want— and I’ve got my opinions— but Bitcoin is an asset that has only been around for 14 years, and hence our data size is minuscule. We’re just stabbing in the dark, really.
In fact, Bitcoin launched in January 2009, only two months before the stock market bottomed in March of that same year (after some kind of crash, you may have read about it in textbooks or perhaps Google also has some info on it). In the decade that followed, we then saw one of the longest and most explosive bull markets ever, an up-only bonanza fuelled by historically low interest rates and a red-hot money printer.
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And yet, people were ready to declare Bitcoin as an uncorrelated asset, a way to diversify a classic stock/bond portfolio. But until last year, it had never even seen a bear market in the wider economy! Even the concept of a positive interest rate was pretty much alien to Bitcoin until 2022. Declaring it a diversifying asset hitherto would be akin to someone who has never tasted alcohol discussing whether Guinness or Coca-Cola tastes better. How are you meant to know how you will react in that situation?
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None of this is particularly insightful. In fact, it’s blindingly obvious, just like the answer to the previous Guinness vs Coca-Cola question. And as I say, the issue over whether Bitcoin will decouple from risk assets in future remains the big question, a fascinating conundrum that is key to the entire investment thesis.
But one thing is certain, and it can be proved objectively true: Bitcoin currently trades like a high-risk asset. And that isn’t hate—it’s just true!
And yet, every time we see even the slightest (and very short-term) dip in the correlation between stocks and Bitcoin, there are headlines circulating such as “Bitcoin has finally decoupled”, “Bitcoin divergence is here”, or “Bitcoin is essential to hedge your portfolio”.
I don’t know whether this is inherent bias from stakeholders within the space, engagement farming or what, but it’s almost impossible to make a strong argument supporting this. Oftentimes, correlation coefficients are quoted in such declarations, something like a highly volatile Pearson metric over a 30-day timeframe, with a (temporary) dip from 0.9 to 0.5. But what does that show?
Or sometimes essential lurking variables are missed. A prime example of this was the regional banking crisis in March when the collapse of Silicon Valley Bank spurred a 20% jump in the Bitcoin price. Here was the ultimate proof of Bitcoin’s residence outside the realm of risk assets, its peerless (fiat) hedge qualities on full display, right?
Well, not really. Because within a creaking banking system, expectations around the Federal Reserve’s ability to hike interest rates in future came down – as we could tell from backing out the probabilities in the Fed futures market both before and after the SVB news. And what is more bullish for risk assets than a dovish turn in interest rate expectations?
In truth, for the question of whether Bitcoin trades like a risk asset, it is superfluous to look at fancy Pearson coefficients; it is unnecessary to build complex models; it is far from essential to spend your days stuck inside on a laptop playing around with any kind of numbers.
You just need to plot Bitcoin’s price against the tech-heavy Nasdaq to see this. Sometimes, the simple solution is the most elegant. Since inflation picked up and the economy transitioned into this new paradigm of tight monetary policy (let’s say Q1 2022), Bitcoin has traded like a levered bet on the Nasdaq.
Look, I love Bitcoin. I think assessing its place within an investment portfolio and speculating about the future path of the asset – and how it fits into the macroeconomic sphere – is absolutely fascinating. I wrote a full book about trying to model its returns going forward, and answering that very question of where exactly it should sit in a portfolio. I really do love it!
But as of right now, Bitcoin trades like a risk asset. It may decouple one day (and that’s a question for another time), but that day has not yet come. It’s hard to argue otherwise, despite what we often hear from those within the space.