The fears of an economic downturn have been growing, and now it is being predicted that there is a similar chance of a recession now as it was in July 2007, just before the 2008 “Great Recession” which acted as a catalyst for the creation of Bitcoin and eventually other cryptocurrencies.
In times of recession, Bitcoin has been described as a safe investment, able to be used by investors as a hedge against a market downturn, in order to reduce total losses.
This leads to the question: What about times when Bitcoin decreases in price? Is it possible to reduce your losses?
The logical solution is diversification. It is a risk management strategy, based on creating a portfolio with various investments. This is done in order to limit exposure to a single risk. However, this strategy is dependent on the assets in the portfolio not being correlated, therefore responding differently to market movements.
In the crypto industry, assets are correlated with the Bitcoin price, effectively making diversification impossible.
Crypto trader @CanteringClark stated that the price of Bitcoin and altcoins have a very high Beta, which is a measure of correlation. A beta of 1.0 means the assets are perfectly correlated, so if one moves in one direction so does the other. A beta higher than 1.0 means that the asset is more volatile than the market, which in this case Bitcoin.
Hyper correlated, High Beta.
With crypto it isn’t called D I V E R S I F I C A T I O N.
— Cantering Clark (@CanteringClark) November 11, 2019
Furthermore, he implied that diversification does not work in the crypto industry, rather calling it “diworsification.”
Let’s take a closer look and see if there is any merit to this claim.
Cryptocurrency Rate of Decrease
In order to test for correlation, we will use the Bitcoin and the altcoin market caps. We will check the price throughout major downward moves and compare the rate of decrease.
For the analysis, we have chosen four downward moves:
- December 2018 – February 2019
- April 8 – 10
- June 27 – July 17
- September 24 – 28
What we have found is that the altcoin price moves in the same direction as that of Bitcoin. This means that they are correlated.
Furthermore, the movement at a higher rate than Bitcoin, making price decreases sharper.
Is Diversification Possible?
In turn, this effectively makes diversification impossible strictly inside the cryptocurrency industry, since assets inside it are correlated with each other. While it may be possible to find a single coin that is negatively correlated with BTC, it is more likely to be a one-off occurrence than a consistent market trend.
One way to reduce exposure would be to diversify your portfolio in cryptocurrency and Tether since the latter is a stablecoin and will not lose value during downward moves.
The full results are given in the table below:
|Dec 2018 – Feb 2019
|April 8 – 10
|June 27 – July 17
|September 24 – 28
Disclaimer: This article is not trading advice and should not be construed as such. Always consult a trained financial professional before investing in cryptocurrencies, as the market is particularly volatile.
Images courtesy of TradingView, Twitter.
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