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Crypto Long & Short: How Bitcoin Correlations Drive the Narrative

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Every week there’s usually at least one article in CoinDesk, a blurb in a newsletter and several charts in the Twittersphere about bitcoin’s correlation with something or other.

This week, we were told that the 60-day correlation between gold and bitcoin (BTC) had reached all-time highs. Last week, our monthly report featured a chart of BTC’s correlation with the DXY dollar index. A few weeks before that, the correlation with the S&P 500 was in the headlines.

If you feel dizzy from the rapid turns in attention on which correlation metric matters, you’re not alone. But, you had better get used to it because the fascination with BTC’s correlation status is unlikely to fade any time soon.

What this reveals about bitcoin is intriguing. It’s not so much the correlation measures per se – they are fun to watch go up and down, but they’re not the deeper story. The deeper story is why it matters so much to us.

When we point to BTC’s increasing correlation with the S&P 500, gold, avocados or whatever, we are searching for a handle on its prevailing narrative. We hope that correlations will give us a clue.

BTC is a difficult asset to pin down. It is a scarce asset like gold, yet with a harder cap. It can be used for pseudonymous transactions, as can cash. It is a speculative holding for many, like equities. It is a bet on a new technology, like a growth stock. It is a hedge against a dollar collapse, a way to spread financial inclusion, an investment in financial evolution, a political statement. It is all of these, or none of these, depending on your intellectual leanings, economic philosophy and mood.

The narrative we choose for bitcoin matters, though. Not only does it form our investment thesis around the asset, but it also influences our valuation methods. Do we extrapolate its potential price using the size of the gold market? The payments universe? Transaction fees? Something else entirely?

So, faced with such a slippery narrative, we look to correlations to tell the story. If it’s highly correlated with gold, then the market views it as a safe haven. If it’s more closely correlated to the S&P 500, then it’s a risk-on investment. If bitcoin’s correlation to the dollar index plummets, then it’s a hedge.

We look to the market to tell us what bitcoin’s narrative is. But this creates a feedback loop (Follow gold! Follow Nasdaq!) that helps to perpetuate bitcoin’s momentum-fueled volatility, and which is often thrown off course by the evolving nature of markets.

Make it a good one

BTC’s 60-day correlation with the S&P 500 has been coming down recently. That must mean it’s no longer a risk-on asset. Its increasing correlation with gold corroborates that, putting BTC back in the safe haven story.

But wait. You’ll have heard that BTC has not had a good run over the past few days. You’ll probably also have heard that Tesla has had a particularly bad time this week. I wonder if they’re correlated.

What do you know, it looks like BTC’s correlation with TSLA is increasing! BTC is now more correlated to TSLA than to the S&P 500. That must mean that bitcoin is now being seen as a tech stock. No wait, it’s being seen as a proxy for market hype. No wait, I mean it’s being seen as a moon shot.

Obviously, I’m kidding, but point I’m trying to make is that short-term correlations can tell a good story, but they’re not that........

© CoinDesk

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