The mysterious Satoshi Nakamoto created Bitcoin (BTC), the first digital currency, as a result of the 2008 financial crisis. The Bitcoin blockchain is the first example of a monetary system operating in a totally decentralized manner bypassing the regular financial system.
From the technological perspective, BTC is a complicated endeavor that involves a lot of moving parts. At RiXtrema, we always try to look at financial problems using quantitative methods and ask unexpected questions. The crazy question of the day is: Will Bitcoin ever be a fiduciary asset?
It may seem crazy today, but I am sure your clients are investing in it and possibly asking you about it. I hear from many advisors who need to answer questions about Bitcoin. In this research note, we will focus on some specific properties of Bitcoin, rather than getting into the intricacies of blockchain.
Bitcoin has some very interesting properties. One is that it has limited supply (it was invented by a libertarian as an analog of digital gold). The other is that it allows the movement of money without capital controls, so it seems to be in demand wherever and whenever there is a financial crisis.
Another really interesting question is if Bitcoin can really be a diversifier. At least intuitively, if it really is in demand during financial crises, it should diversify and then there may be some hope for it.
Can we use BTC as a diversifiable asset that is at least somewhat immune to the total market?
To answer this question it is natural to inspect the time series of BTC versus the standard market indices in equities and fixed income. Comparing the return series of BTC versus those we get the following result:
There are some basic conclusions we can draw from this graph.
- BTC is order of magnitudes more volatile than the other market indices.
- BTC returns seem to have moderate correlation with S&P 500 and MSCI World.
Let’s look at the numbers. Despite correlation being moderate, a surprising result is that Bitcoin actually has a positive correlation with S&P 500. That number is .18. So it is far from the hedge against financial system disorder that many believe it to be.
Looking at volatilities, it is clear Bitcoin is not for the faint of heart.