Sign in Subscribe
Featured

From Macro to Micro: Can Narrative Shifts Spark the 'Decoupling'?

A potential 'decoupling' could provide investors with new opportunities for portfolio construction, allowing them to leverage more diversification benefits in their investment strategies.

Gabriel Selby

• 4 min read
From Macro to Micro: Can Narrative Shifts Spark the 'Decoupling'?

With more idiosyncratic narratives emerging, digital asset prices are becoming less correlated with traditional markets.

"There is no such thing as a free lunch"

Renowned Nobel laureate Harry Markowitz once said that diversification is the only "free lunch" in the world of investing. This is because the benefits of a properly diversified portfolio with various asset classes can allow an investor to drastically reduce the overall risk of their portfolio, without materially reducing the portfolio's return potential. To put it simply, diversification is a powerful strategy that enables investors to potentially optimize their gains while safeguarding against unnecessary risks.

In investing, practitioners can use a correlation statistic to measure the association between different financial assets. Correlations range from -1 to 1, with a positive correlation signifying that both assets move together, no correlation meaning there is no relationship, and a negative correlation indicating movement in opposite directions. Investors use it to diversify portfolios and manage risk effectively by selecting assets with low or negative correlations.

In the early days, one of the key advantages of investing in cryptocurrencies like Bitcoin was its close-to-zero correlation to traditional markets. The illustration below depicts the rolling 20-day correlation of our CF Floating Broad Cap Index with the Nasdaq 100 Index over the past decade (note: I'm using 20 periods since there are typically 5 business days in a week). Prior to 2020, digital assets maintained an average correlation of just 0.04 with the tech-centric equity market index. Many practitioners consider any correlation near zero as an indicator of an uncorrelated asset.

In more recent times, the average correlation of this asset class has risen to 0.23. This has thrown some cold water on the theoretical benefits of using cryptocurrencies as a diversifying piece of an investor's portfolio. However, this metric has recently breached its lowest recorded level since the pre-2020 period.

Source: CF Benchmarks, Bloomberg as of July 25, 2023

How did we get here?

Narratives have evolved over time. In 2020, the global pandemic triggered a synchronized wave of monetary and fiscal stimulus, which bolstered financial assets across the risk spectrum, including cryptocurrencies. This led to closely tied pricing relationships. However, the eventual arrival of inflationary pressures meant that these tailwinds would shift to headwinds, reversing the directional bias but keeping these very same pricing relationships between risky and non-risky assets relatively stable.

The illustration below shows statistical correlations between our broadest institutional measure of the crypto market (CF Floating Broad Cap Index) and other indices in various asset classes. Last year, we can see how positively correlated digital assets were to equities during this period of rising interest rates and market volatility, which dominated the headlines.

Correlations have shifted

Possible new catalysts are emerging

Analyzing a more recent period (shown directly above), one can observe the shifting correlations across the board, likely due to a confluence of narratives and potential bullish catalysts discussed below.

  • The spot ETF frenzy: Leading asset managers, like BlackRock, may have discovered a formula to meet the S.E.C.'s demands for obtaining regulatory approval for a spot Bitcoin ETF in the U.S. This has triggered a wave of filings from traditional asset managers, who all wish to now offer a regulated and practical way for conventional investors to gain exposure to the world's most valuable digital asset for the very first time. The potential market impacts of this development are significant, as unlocking access to such a fund structure could introduce a new wave of retail and institutional investors to the Bitcoin market for the very first time. (Note: To delve into the nuances of why this time might be different for spot ETF approvals, watch our latest podcast episode.)
  • Regulatory clarity: A recent ruling from a federal court has provided some crucial guidance on how tokens are classified as securities or not. The distinction between a token's classification has been a subject of debate since the S.E.C. sued Ripple (XRP) in December 2020. While the debate is not fully settled, early indications from this case suggest that XRP may not always be considered a security. The outcome of this case is anticipated to have a widespread impact on the industry, leading to highly reactionary pricing sentiment towards these tokens.
  • Ramping up sound-money principles: The two largest tokens, which currently account for over $700Bn in market cap and approximately 90% combined weight of our CF Floating Broad Cap Index, are experiencing favorable supply dynamics now or in the near future. The approaching bitcoin halving in 2024 will slash block rewards given to miners in half. Meanwhile, last year's Ethereum proof-of-upgrade has provided a consistent deflationary force to its token supply, as more tokens are being "burned" or destroyed through network transactions.

Now we wait and see...

Surely, this observable window is not long enough to extrapolate any definitive structural changes in market correlations between cryptocurrencies and traditional assets. However, as we continue to navigate these shifts from macro to micro narratives, one cannot rule out the possibility of a 'decoupling'. Such a scenario would provide investors with another lever to pull in their portfolio construction process, potentially enabling more opportunities for "free lunches".

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell any of the underlying instruments cited including but not limited to cryptoassets, financial instruments or any instruments that reference any index provided by CF Benchmarks Ltd. This communication is not intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. Please contact your financial adviser or professional before making an investment decision.

CF Benchmarks Ltd (“CF Benchmarks”), a company registered in England and Wales with company number 11654816 and authorised and regulated by the Financial Conduct Authority. Information about us can be found on the Financial Services Register (register number 847100).

Registered Office: 6th Floor One London Wall, London, United Kingdom, EC2Y 5EB.

You agree not to, and have no rights to, use the CF Benchmarks Data to create, calculate, issue, settle, maintain, support or develop any financial instruments (including but, without limitation exchange traded products, certificates, warrants, contracts for difference, swaps, binary options, structured products), indices, products, services (including but without limitation, portfolio management services, pre- and post-trade risk management services, or valuation services) or any other derivative works without the express written consent of CF Benchmarrks.

You agree not to analyze, reverse-engineer or disassemble any CF Benchmarks data and not to insert any code or product to manipulate the Website content in any way that affects any user’s experience. Unless CF Benchmarks gives you prior written permission, use of any Web browsers (other than generally available third-party browsers), engines, scripts, software, spiders, robots, avatars, agents, tools or other devices or mechanisms (such as crawlers, browser plug-ins and add-ons, or other technology) to navigate, access, copy in bulk, retrieve, harvest, index, search or analyse any portion of the Website is strictly prohibited.

No part of this information may be reproduced, stored in a retrieval system or transmitted in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, without prior written permission of CF Benchmarks Ltd. Use and distribution of the CF Benchmarks data requires a license from CF Benchmarks or its authorized licensing agents.

All information is provided for information purposes only. All information and data contained on this website is obtained by CF Benchmarks, from sources believed by it to be accurate and reliable. Such information and data is provided "as is" without warranty of any kind.

CF Benchmarks, nor its directors, officers, employees, partners or licensors make any claim, prediction, warranty or representation whatsoever, expressly or implied, either as to the accuracy, timeliness, completeness or merchantability of any information or of results to be obtained from the use of the CF Benchmarks indices or the fitness or suitability of the same indices for any particular purpose to which they might be put. Any representation of historical data accessible through CF Benchmarks indices is provided for information purposes only and is not a reliable indicator of future performance.

No responsibility or liability can be accepted by CF Benchmarks nor their respective directors, officers, employees, partners or licensors for any loss or damage in whole or in part caused by, resulting from, or relating to any error (negligent or otherwise) or other circumstance involved in procuring, collecting, compiling, interpreting, analysing, editing, transcribing, transmitting, communicating or delivering any such information or data or from use of this website or links to this website.

CF Benchmarks and its respective directors, officers, employees, partners or licensors do not provide investment advice and nothing accessible through CF Benchmarks, should be taken as constituting financial or investment advice or a financial promotion. Charts and graphs are provided for illustrative purposes only. Index returns shown may not represent the results of the actual trading of any assets.

CF Benchmarks is a member of the Crypto Facilities group of companies which is in turn a member of the Payward, Inc. group of companies. Payward, Inc. is the owner and operator of the Kraken Exchange, a venue that facilitates the trading of cryptocurrencies. The Kraken Exchange is a source of input data for certain CF Benchmarks indices. Payward, Inc. is the owner and operator of the Staked, a venue that operates the block production nodes for decentralized PoS protocols on behalf of institutional investors. Staked.us is a source of input data for certain CF Benchmarks indices.

Please refer to the individual product family documentation for more information about applicable input data sources.