Introduction
Over a longer time frame, we think the key themes of geopolitical tension and global monetary tightening have led to a convergence in risk asset performance in recent months. This has been visible in the rising correlation between crypto (bitcoin) and traditional assets like tech stocks (Nasdaq 100) with that figure now close to ~45% based on a rolling window of 90-day returns (though the average including 2H22 until now is actually lower at 25-30%.) While that 25-30% could be considered relatively small, compare that to an average correlation of 18% in 1H21 or closer to 10% from 2016-2020.
In part, this recent increase reflects the size and scale of the shock to the financial system caused by the invasion of Ukraine and the important unknowns to be worked out in the weeks ahead. Removing Russian banks from the SWIFT messaging and payment order system could create settlement issues for non-Russian (mainly European) banks. Multinational companies divesting themselves of Russian holdings could see their corporate earnings impacted negatively. The sanctions imposed by the US, Europe, UK and Canada on Russian central bank reserves have impacted the ruble (RUB), but at a cost – this also drains the global system of roughly US$300B in reserve liquidity, which has the potential to hurt risk assets in the weeks ahead.
All of these things represent potential externalities for the global economy, from which crypto is not necessarily immune. That is, investors who own crypto assets and ascribe value to say the scarcity of bitcoin may also be invested in other assets like stocks, and when there is newsflow that challenges the price action in a significant way, behavioral bias may lead to broad based selling.
But the value of crypto as a possible hedge for other assets (stocks, bonds etc) in a portfolio stems from the factors that drive its performance on a secular basis such as disruptive technology, security considerations, reduction in transactional frictions, supply factors, liquidity, market adoption (Metcalfe’s Law) or even regulatory developments. These are very different from the factors that impact bond performance (inflation and interest rates) or stock performance (corporate earnings, growth, risk free rates.)
Moreover, the digital assets that make up this asset class are not uniform and in many cases serve as both productive as well as financial capital for a particular protocol. As a result, they don’t carry the same properties as equities or bonds or commodities, which at times can make these assets easier to price than value.
Over time, we would expect to see the correlation to traditional markets rise as blockchain technology becomes more mature and less of a high-growth investment opportunity. Regardless, we think crypto could present a suitable hedge for traditional assets in a portfolio.
