As the bitcoin market continues to mature, with more players entering and liquidity growing to support broader uses, the world’s favorite cryptocurrency is beginning to reflect movements of the USD with an astoundingly high correlation.
Bitcoin, a new entrant to the forex world, is just beginning to find its place among the world of alternative assets. Many assume that bitcoin, as a decentralized, non-state issued currency, would gain value as inflationary pressures on traditional currencies increase. If that were the case, it would more closely follow existing inflation hedges, most notably gold, but that has not been the case. As shown in the chart below, BTC’s correlation with gold is not only relatively insignificant, it’s actually been -0.4 since the market settled following the mid-April crash.
Bitcoin is known for being a volatile asset, with prices as low as $13 and as high as $260 in 2013 alone, which has led many to declare it unpredictable. As it turns out, not only have bitcoin exchange rates been predictable over the past two months, they actually follow the currency for which bitcoin has the highest propensity to disrupt.
Looking at data over the same time period, since May 1 of this year, daily bitcoin price movement has had a 0.76 correlation with USD. The correlation actually increases to 0.89 when shifting USD three days forward. Said otherwise, since May 1, BTC prices have had a 0.89 correlation with three-day-old USD index levels.
The predictive nature of USD for bitcoin may surprise some, but the underlying fundamentals of their high correlation may make sense, at least for the time being. Historically, the US dollar has served as a risk-averse asset, gaining value as traders pull out of other financial products during periods of uncertainty and doubt. Bitcoin seems to be following the same path, serving as an alternative asset for those averse to the USD’s susceptibility to inflationary central policy.
One important implication of this correlation is that it means bitcoin is effectively even more volatile than people would assume. USD is by far the largest exchange market for BTC with approximately 75% of total volume. If the two assets are correlated, it means that when BTC rises, it increases not only by the value compared to USD, but also by the gains USD made relative to other currencies.
Bitcoin has a long road ahead as increasingly sophisticated players enter the market. It’s role as an alternative asset will continue to be refined in the years to come, but the way it’s been used recently is quite clear.