We are going to analyze several of the major cryptocurrencies as an asset class. And, we are going to address several related questions:
4) Are cryptocurrencies truly “digital Gold”? Do they behave in a similar way given that their supply is constrained (supposedly in a similar way as Gold is)?
You can review the complete analysis at the following links:
Crypto analysis at SlidesFinder
Publicly available data on cryptocurrencies is fairly limited in terms of length of time series. Also, many cryptocurrencies started in just the past few years. Given that, I am focusing the first part of this analysis on monthly data from September 2015 to March 2022. I also conducted fairly extensive analysis using daily data that you can review within the links disclosed above.
When looking at correlations over the reviewed period as shown on the table below, we observe that both cryptocurrencies and gold have very low correlations with the stock market (S&P 500).
Thus, one could derive that cryptocurrencies do provide diversification benefit from equity market risk.
However, during the one market correction (within this period), we observe that cryptocurrencies did not provide any diversification benefits. While the S&P 500 contracted by close to - 30% between February 19 and March 16, 2020, the cryptocurrencies' respective values often contracted by more than - 50%.
As shown earlier, cryptocurrencies have very low correlations with gold. Thus, they can't be considered "digital gold", as they behave completely differently.
The critical differentiating characteristic of cryptocurrencies is their volatility. Their volatility is a high multiple higher than the stock market (S&P 500). The graph below is focused on the volatility level-dimension that is specified as the annualized standard deviation using monthly % change. And, the Y-axis as disclosed, when it shows a standard deviation of 7.5 ... it actually means a standard deviation of 750% (as a reference the S&P 500 annualized standard deviation over that period averaged about 14%). Within the complete analysis, you can see details of the underlying calculations.
As shown above, both XRP and Dodge experienced the highest volatility with both peaks for several months at or above 750%.
When we focus our graph on the time dimension (see below), we observe that XRP experienced its peak volatility in 2018. Meanwhile, Dodge experienced it 3 years later in 2021.
Next, let's look at the cryptocurrencies volatility (as defined) as a multiple of the S&P 500 volatility. As shown on the graph below, these multiples range from single digit multiple up to > 200 x. That's pretty amazing. It is actually hard to comprehend unless you look at the underlying data firsthand.
As we speak, the cryptocurrencies are experiencing a severe correction (far worse than any stock market correction). While the S&P 500 has corrected by about - 6% during this recent Winter, the cryptocurrencies have dropped between - 30% and - 80% since their most recent peak (some cryptocurrencies have been on a volatile slide since May of 2021). This is a second instance when cryptocurrencies have provided no diversification from equity risk.
In view of the above, cryptocurrencies may be considered an asset class given that their behavior is very much different from other asset classes (at least the ones reviewed including equities and gold; and they certainly behave completely differently than bonds. You don't need a study to assess that).
However, as mentioned they do not provide so far any diversification benefit to protect against equities markets downturns. And, their huge volatility renders them inappropriate for any conservative and/or long-term investor.
