Bitcoin, the notorious cryptocurrency, is well-known for its extreme volatility. Its price swings can be likened to a roller-coaster ride, with drops of over 64% in one year followed by rallies of 160% in the next. On the other hand, the S&P 500, a key benchmark for the U.S. economy, offers a more stable performance, averaging 9% to 10% annual returns. While Bitcoin may provide higher returns, the consistency and reliability of the S&P 500 make it a preferred choice for risk-averse investors seeking predictable outcomes.
According to Glassnode, allocating a small portion of a portfolio to cryptocurrency can help diversify risk and enhance returns in traditional portfolios. For instance, adding allocations to the Coinbase Core Index (COINCORE), a market-cap weighted index primarily composed of Bitcoin and Ether, to a 60/40 portfolio increased both absolute and risk-adjusted returns over a five-year period. Despite the volatility of Bitcoin, it has the potential to provide diversification benefits and improve overall portfolio performance.
Contrary to expectations, Bitcoin has displayed minimal correlation with major asset classes, despite the introduction of Bitcoin ETFs. Data from Glassnode and Coinbase Institutional reports show that Bitcoin’s correlation with traditional assets like the S&P 500 is low at 0.11. This suggests that Bitcoin’s price movements are largely independent of traditional markets, making it a valuable component for diversification within a portfolio.
In recent quarters, Bitcoin has experienced fluctuations in correlation with other assets. At the start of Q2, Bitcoin prices dropped 15% while the DXY index rose above 106, highlighting a negative correlation between the two. Additionally, Bitcoin’s volatility has decreased since January 2020, indicating a long-term downward trajectory in volatility despite occasional spikes.
As Bitcoin matures into a major asset class, its volatility is expected to continue declining over time. Research from Tastylive suggests that there is little correlation between Bitcoin and the S&P 500, except during significant price movements of Bitcoin. When Bitcoin’s price movement exceeds 5%, it creates a favorable environment for risk-on trading, leading to bull rallies for both Bitcoin and the S&P 500. This shift in correlation indicates that Bitcoin is increasingly behaving like a risk-on asset rather than a safe haven, attracting investors looking for higher profit potential.
The relationship between Bitcoin and traditional markets is complex and evolving. While Bitcoin offers high volatility and potential returns, the stability of traditional assets like the S&P 500 remains appealing to risk-averse investors. Including small allocations to cryptocurrency in portfolios can provide diversification benefits and enhance overall returns. As Bitcoin continues to mature as an asset class, its correlation with traditional markets is likely to change, presenting new opportunities and challenges for investors.