Ryan Giannotto
For investors new to the crypto ecosystem, the natural impulse is to try to visualize digital assets within a framework of well-known and familiar investments—we understand what is novel in terms of what we know. To help investors break the digital ice, our task is to see which assets best simulate the role and behaviours of cryptocurrencies.
Ultimately no other investment serves as an entirely seamless proxy for crypto, even within the risk-on category of assets. If we expand the mental framework for this question, however, we can see that gold often best analogizes digital assets' role as a non-correlating, if volatile, investment.
Out of Stock: Crypto Comparisons
Show me your correlations, says the statistician, and I will tell you what you are. There is a prevailing assumption that digital assets behave like growth equities, but as which much received wisdom, this narrative is at odds with empirical data. The key factor is that for all their volatility, digital assets are remarkably uncorrelated to stock market risk. For instance, Bitcoin maintained a daily correlation to the Russell 1000 Index of only 0.231 since the end of 2015; this value means the two assets explain only 5.3% of each other’s returns, an impressively small figure.[1] Should the same analysis is run against the Russell 1000 Growth Index, the explanatory power increases to only 5.7%.
Even if we purposely select the stocks with the greatest sensitivity to the digital asset ecosystem, the connection remains tenuous from a quantitative perspective. The makers of Graphical Processing Units (GPUs) in the semiconductor space are arguably best positioned as stock market proxies for cryptocurrencies, as they manufacture the devices used to mine and power many blockchain platforms. Indeed, the leading actors in this segment, AMD and Nvidia, had their stocks priced as low as $2 and $5 in 2015—each has since witnessed over a 60-fold rally.
Correlation of Bitcoin to AMD/NVDA Portfolio
Source: FTSE Russell Data, as of May 31st, 2023. Rolling correlations of the FTSE Bitcoin Index against an equal-weight portfolio of AMD and Nvidia, rebalanced annually. Past performance is no guarantee of future results. Please see the disclaimer for important legal disclosures.
Constructing an equal-weight portfolio of these two companies, rebalanced annually, illustrates just how different cryptocurrency and (modestly) crypto-correlating stocks can be. The figure above depicts the 100 and 200-day rolling correlations between the aforementioned GPU portfolio and Bitcoin since 2015. Notably, the average correlation over the preceding three years is only 0.253, meaning even the best candidate for a digital asset proxy in the stock market explains only 6.5% of crypto returns, an insignificant sum.
At the height of the 2022 H1 drawdown, the 100-day correlation between Bitcoin and the GPU portfolio peaked at 0.620. This figure is certainly elevated, but it remains somewhat unremarkable given the depth of the sell programs that were pervading all asset classes at the time. A total of 63% of returns are attributable to other risk factors; even in the most favourable possible circumstances, the potential for crypto-proxy behaviour is limited indeed.
Reframing Digital Assets: Leveraged Gold and Bitcoin
Source: FTSE Russell Data, as of May 31st, 2023. Bitcoin represented by the FTSE Bitcoin Index. Past performance is no guarantee of future results. Please see the disclaimer for important legal disclosures.
Moreover, this period of higher correlation should be viewed as a deviation from long-run patterns, and not as a typifying trend. In 2023 the rolling correlations are rapidly approaching long-term averages, and indeed the 50-day correlation stood at 0.07 as of May 31st. Hence, in a period of profound market stress, digital assets correlations only resembled the very closest stocks as much as utilities historically correlate to broad equities, which is to say they trade quite distinctly.
Another challenge arises in that these stocks only became crypto-correlating, and subject to meteoric rise, after the emergence of digital assets—it is a classic causation problem. Investors therefore cannot examine AMD and Nvida in the early 2000s and draw inferences of how digital assets might have behaved in such a period. The truth is that no equity serves as an analogue for digital assets, either pre or post the crypto big bang, because stocks and digital assets do not behave like one another.
What is the Right Digital Benchmark?
If under the most conducive of circumstances possible, stocks do not parallel digital asset performance, where else can investors turn for a benchmark? Other alternative currencies, namely gold, best serve as substitutes for cryptocurrencies in terms of store of value, medium of exchange and non-correlative properties. Gold has demonstrated idiosyncratic returns and long-term gains since 1971; amplifying gold’s daily returns by 400% (the vol differential between gold and Bitcoin) and it could be easily mistaken for a digital asset. This assertion does not imply that gold and bitcoin model each other’s behaviour, merely that they are both in a non-correlating class of assets.
Moreover, some of the PGM’s (Platinum Group Metals) do exhibit crypto-level volatility and trading patterns—palladium achieved 49% annualized volatility over the last year, and rhodium 215% volatility over the last 20 years. Indeed, these more exotic metals may be representative of the broader basket of digital assets now available to investors. While not stocks, gold, palladium and rhodium – for the moment – are proving the best assets to contextualize digital asset performance and their diversifying role in the portfolio.
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