- The prices of cryptocurrencies were highly correlated in 2018 with correlation growing substantially this year
- The most correlated cryptocurrency was Ethereum followed by Bitcoin while the least correlated one was TRON
- The traded volume of cryptocurrencies were also correlated, although significantly less so than prices
- Bitcoin and Ethereum had the most correlated traded volume
Increasingly it’s becoming clear: if you own one cryptocurrency, you own them all. One of the issues not talked about enough in crypto is inability to truly diversify cryptocurrencies simple because cross-asset correlations are extremely high. When Bitcoin’s price is falling, generally the price of the majority of other cryptocurrencies will fall as well.
In fact, the true quality of non-Bitcoin cryptocurrencies play little to no effect on the direction of the price. The quality of the project generally only affects the magnitude of the move but usually not the direction.
If permissionless finance wants to progress, there is a dire need for on-chain crypto-collateralized derivative markets with sufficient liquidity. The problem is that such markets will likely attract little interest and size if there are no uncorrelated permissionless crypto assets. It’s possible that the emergence of tokenized securities can help mitigate this problem since their price will, by definition, be uncorrelated with permissionless cryptocurrencies. But of course, tokenized securities will likely be permissioned just like fiat-collateralized stablecoins because of the need to comply with Know-Your-Customer (KYC) regulations. Therefore it’s crucial that the price of permissionless cryptocurrencies decouple from each other.
In order to measure the correlation between the cryptocurrencies, the Pearson correlation coefficient is used. The coefficient ranges from -1 to 1. A correlation of 1 shows a perfect positive correlation while -1 shows a perfect negative correlation. A correlation of 0 shows no relationship between the movement of the two variables. Daily prices of Bitcoin and ten other largest cryptocurrencies by market capitalization are used (Ethereum, XRP, Bitcoin Cash, EOS, Stellar, Litecoin, Tron, Cardano, IOTA, and Monero). A table showing correlation coefficients between all the analyzed cryptocurrencies in 2018 can be seen below.
Correlation between the price of crypto assets in 2018
The table shows that all the analyzed cryptocurrencies are positively correlated with other cryptocurrencies. The two largest cryptocurrencies, Bitcoin and Ethereum, correlate the most with the other analyzed cryptocurrencies. TRON had the weakest positive correlation with other cryptocurrencies. When reviewing correlations between two specific cryptocurrencies, the most correlated pairs (coefficient larger than 80%) were Cardano/Stellar, Bitcoin/Litecoin, Monero/Ethereum, Ethereum/Litecoin and Monero/Litecoin. The least positively correlated pair in 2018 was Tron/Stellar with a coefficient of less than 42% (see graphs below). It’s also worth noting that Proof of Work currencies tend to correlate less with other alternative consensus mechanisms.
For comparative purposes, it’s worth running the same analysis for 2017. Only the cryptocurrencies that have a full year of trading data were used, which leaves Bitcoin, Ethereum, XRP, Stellar, Litecoin and Monero. Perhaps not surprisingly, all the observed cryptocurrencies are still positively correlated but weaker in 2017 than in 2018. This was likely caused by more speculation in 2018 and generally larger traded volume. Cryptocurrencies were used more as a trading instrument, which potentially coupled the prices further.
Correlation between the price of crypto assets in 2017
On top of price correlation, we also see correlations between traded volumes. Although the reported volume is likely impacted by manipulation, it’s still an important indicator if we assume that manipulation affects all the cryptocurrencies in similar magnitudes. In 2018, the reported traded volume of Bitcoin surpassed $2.2 Trillion. Ethereum trailed with a little over $830 Billion. Overall, the total reported traded volume of the observed cryptocurrencies neared $4.3 trillion in 2018. Unsurprisingly, the volume of Bitcoin correlates the most positively with other cryptocurrencies.
Correlation between the traded volume of crypto assets in 2018
As can be seen in the table above, the most closely correlated volume by far is that of Bitcoin and Ethereum. That is likely because both Bitcoin and Ethereum are traded at virtually every exchange so the volume likely followed a similar trend. The least correlated pair is Monero and Tron.
Similarly, as with prices, the traded volume was less correlated in 2017 than in 2018.
Correlation between the traded volume of crypto assets in 2017
The trend of the growing correlation between cryptocurrencies is troubling. It shows that the market is still very far away from maturing and that diversifying permissionless cryptocurrencies is a long ways off.