By Daniel Barrera, Senior Associate, MSCI Research, and Simon Minovitsky, Vice President, Equity Research Team, MSCI.
Bitcoin: good as gold?
Gold has historically been used by investors for diversification and as a hedge against inflation, as it’s tended to perform well, or at least keep its value, in inflationary periods when equities have tended to perform poorly.
The limited supply of popular cryptocurrency Bitcoin and others resembles the limited availability of gold. Only 21 million units of Bitcoin can ever be mined and there were already more than 18.67 million units in circulation as of March 25, 2020.
But what are the empirical characteristics of the returns of cryptocurrencies, and did they zig when equities zagged?
Would cryptocurrencies have worked as a hedge for a traditional equity portfolio?
The short answer is no. Even though prices of cryptocurrencies had no direct economic linkage with equities, our analysis of volatility, correlations, and drawdown behavior suggests that these digital assets are quite different from gold and, perhaps, not different enough from equities.
Cryptocurrencies also still face limited acceptance as a medium of exchange, although this has increased dramatically in the last 12 months. A number of large financial institutions, including Morgan Stanley, JPMorgan Chase, Goldman Sachs, BlackRock, and Fidelity Investments recently announced they will start offering Bitcoin exposure to wealthy clients. In addition, a few high-profile nonfinancial companies such as Tesla, MicroStrategy, and Square, have taken large positions in Bitcoin, and the number and total market cap of cryptocurrencies, generally, continue to grow. We show the top 30 by market cap in the exhibit below. As of March 31, Bitcoin was by far the largest, with a market cap of $1.112 trillion, which was ten times larger than Ethereum, the next largest coin.
Source: MSCI.
Assessing volatility
We start our analysis by comparing volatilities. For equities, we used the MSCI ACWI Investable Market Index (representing 99% of the global equity investment opportunity); for cryptocurrencies, the MVIS CryptoCompare Digital Assets 100 Index (a capitalization-weighted index tracking the 100 largest cryptocurrencies) and the MVIS CryptoCompare Bitcoin Index in USD (to isolate Bitcoin returns); and for gold, we used the spot price. We confirmed the common perception that cryptocurrencies have been more volatile than equities and gold over the last five years by factors of six and five times, respectively, as shown in the following exhibit.
Source: MSCI.
Correlations of top cryptocurrencies with the equity market
We next calculated correlations of 12 cryptocurrencies versus the MSCI ACWI IMI over the last five years and found they averaged near zero with frequent oscillations that have gone as low as -0.3 and as high as +0.3. These findings indicate there were periods when cryptocurrencies would have been a weak hedge but others when it wouldn’t have worked as one at all.
Source: MSCI.
The upshot on drawdown behavior
Last, we examined how much downside protection cryptocurrencies would have provided over the last six years during the times when an equity investor needed it the most — when equity markets fell the farthest. We found that in the months when equity markets fell more than 3%, Bitcoin also fell (in eight out of 12 instances) and tended to fall even more than equities. In contrast, gold tended to have positive returns (in eight out of 12 instances) during these drawdown periods.
Source: MSCI.
Cryptocurrencies lacked gold’s shine
We found that while cryptocurrencies have had a low correlation to equities over the last five years, on average, those correlations varied greatly over time. Furthermore, cryptocurrencies would not have provided downside protection to an equity investor when they needed it most — as gold did. In short, cryptocurrencies were not as good as gold when it came to hedging a traditional equities portfolio.
(The views expressed here are those of the authors and do not necessarily reflect those of ETF Strategy.)