We summarise a 2022 paper that examines whether Bitcoin and the aggregate cryptocurrency market acts as a diversifier, hedge or safe haven to US stocks, bonds, US dollar, commodities, real estate and gold.

LITERATURE

In this Literature Review, we discuss the 2022 paper titled “Cryptocurrencies, Correlations, and COVID-19: Diversifiers, Hedge or Safe Haven?”, co-authored by Brian Lavelle, Katherine N. Yamamoto and Michael Kinnen. The paper was published in the Review of Integrative Business & Economics Research.

QUICK VIEW

The study compares and distinguishes whether Bitcoin and the crypto market are:

• A diversifier – An asset that has a weak positive correlation with another asset on average.
• A hedge – A weak (strong) hedge is an asset uncorrelated (negatively correlated) with another asset on average.
• A safe haven – A weak (strong) safe haven is an asset uncorrelated (negatively correlated) with another asset on average during times of stress.

The study finds that Bitcoin acts primarily as a diversifier to other traditional assets, a strong hedge to aggregate crypto currencies, and neither a strong nor weak safe haven when compared with traditional assets. Interestingly, the study finds the cryptocurrency market as a whole is primarily a strong hedge to other traditional assets.

THE DATA

For the study, the authors analysed daily price values for Bitcoin, the aggregate cryptocurrency market, US stocks, bonds, the US dollar, commodities, real estate and gold from 2^nd January 2015 to 21^st July 2020.

Bitcoin data was obtained from CoinMarketCap.com, which aggregates Bitcoin prices across various crypto exchanges.

As a proxy for the aggregate cryptocurrency market, the study used the CCi30 Index, an exponentially weighted moving average index designed to track the 30 largest cryptocurrencies by market capitalisation, including Bitcoin and excluding stable coins. The index statistically represents the aggregate cryptocurrency market at a confidence level of 99% and with a margin of error value of just 1%. This allows it to objectively measure the overall growth and movement of the blockchain sector.

The proxy for US stocks was the S&P 500 while bonds were represented by the Vanguard Total Bond Market Index Fund (BND), which tracks a benchmark of US government, corporate and other US dollar-denominated fixed income securities.

The US dollar index (DXY), which tracks the strength or weakness of the dollar against a basket of foreign currencies was used as a proxy for domestic currency.

The proxy for commodities was the S&P Goldman Sachs Commodity Index (SPGSCI), which benchmarks the performance of the aggregate commodities market including oil and energy, industrial materials, and agricultural commodities.

For the real estate market, the proxy was the Vanguard Real Estate Index Fund (VNQ), which tracks a benchmark of publicly traded US REITs. Finally, the US dollar gold spot price was the proxy for gold.

METHODOLOGY

In this study, Engle’s (2002) dynamic conditional correlation is used to estimate the diversifying, hedge or safe haven properties of Bitcoin and the aggregate cryptocurrency market in relation to commonly held portfolio asset classes.

The study evaluates Bitcoin and the aggregate cryptocurrency markets’ safe haven, hedge or diversifying properties by first splitting the data into a train and test set consisting of 1,355 train observations and 50 test observations. A model is then built for each of the assets under investigation.

KEY FINDINGS

Source: Lavelle et al.

• Bitcoin as a diversifier: The study found that Bitcoin acts primarily as a diversifier in investors' portfolios. Therefore, a US investor holding stocks, bonds, cash, real estate and gold would achieve portfolio diversification benefits from holding Bitcoin. In only two assets – aggregate cryptocurrencies and commodities – was Bitcoin anything other than a diversifier.
• Bitcoin as a hedge: Surprisingly, Bitcoin is a strong hedge for the aggregate cryptocurrency market. This result is surprising given Bitcoin represents a large portion of the cryptocurrency market capitalisation. Bitcoin was also a strong hedge for commodities, demonstrating its ability to counter commodity risk.
• Bitcoin as a safe haven: When considering extreme shocks in the assets under investigation, the regression estimations suggest Bitcoin is neither a weak nor strong safe haven. Investors should search for safety elsewhere in times of market turbulence.

Source: Lavelle et al.

• Cryptocurrencies as a diversifier: In only the case of the US dollar does the aggregate cryptocurrency market act as a diversifier.
• Cryptocurrencies as a hedge: The study indicates that the aggregate cryptocurrency market strongly hedges the daily returns of Bitcoin, stocks, bonds, commodities, real estate and gold.
• Cryptocurrencies as a safe haven: When considering extreme shocks, the estimates suggest the cryptocurrency market does not provide a safe haven in times of extreme volatility for investors.

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