What Does Lower Bitcoin-Ether Correlation Mean for Investments?

by James · April 24, 2023

The prices of bitcoin and ether – the two largest cryptocurrencies by market capitalization – are usually closely correlated, but that is changing after Ethereum’s Shanghai upgrade, and that could affect investment and risk management for cryptocurrency investors.

KEY EXTRACTION

Ether and bitcoin have moved together in the past, with the exception of the time period around The Merge.
The lack of correlation increased after Ethereum’s Shanghai (Shapella) hard fork.
At the same time, bitcoin has continued its correlation with the Nasdaq.

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Ether and Bitcoin’s correlation

According to a recent report from Coinbase, the correlation between bitcoin (BTC) and ether (ETH) has been declining since the beginning of 2023, and the break widened after Ethereum’s Shanghai (Shapella) hard fork. The upgrade, which was completed on April 12, allowed users to withdraw staked ether for the first time.

The BTC-ETH correlation based on a 40-day rolling window has fallen from 0.95 to 0.82 during that time. In the past, these two cryptoassets have mostly moved lock steps.

The report attributes this trend to several factors, such as the growing use of Ethereum-based decentralized applications (DApps), the growing popularity of non-fungible tokens (NFTs), and the transition of the network from a proof-of-work (PoW) to a proof-of-stake (PoS) consensus mechanism.

How Declining Correlation Affects Investments

Lower BTC-ETH correlation may have implications for portfolio diversification and risk management. For institutional investors, it may mean a change in their hedging strategies.

“The relevance of this falling correlation for institutional investors is that it could affect quantitative strategies that rely on cross-hedging one asset for the other (or using ETH as a hedge for less liquid altcoins),” Coinbase analysts said.

For investors looking to gain exposure to the cryptocurrency market, holding both BTC and ETH can offer more benefits than holding either alone, as they can reduce overall volatility and increase the potential returns of their portfolio.

However, the report cautions that correlation is not a static measure and may change over time depending on market conditions and developments in both networks.

Bitcoin is still correlated with the Nasdaq

Bitcoin is often touted as a hedge against inflation and a safe haven in times of economic turmoil. However, a recent analysis by CoinDesk shows that the cryptocurrency’s correlation with the ratio of the Nasdaq 100 to the S&P 500 index has increased significantly since late 2020, suggesting that bitcoin may be more sensitive to changes in market sentiment and risk appetite than previously thought.

The relationship between the Nasdaq 100 and the S&P 500 reflects the relative performance of growth stocks versus value stocks. Growth stocks are typically associated with higher earnings growth potential and higher valuations, while value stocks are seen as undervalued and often pay dividends.

According to CoinDesk, bitcoin’s 90-day correlation coefficient with the Nasdaq-to-S&P 500 ratio rose to an all-time high of 0.79 in March 2021, up from -0.06 in September 2020.