June 2, 2023
Greg Cipolaro

Research Weekly - Correlations in a Post Stimulus World


  • Bitcoin’s correlation with equities continues to fall. We look at the impact fiscal and monetary stimulus had on correlations and offer a view of what correlations might look like in the future.
  • Bitcoin's volatility, a measure of risk, continues to fall, but what does that say about returns?
  • Bitcoin’s mempool stay full, but fees are declining as transaction immediacy falls.

Correlations Decline as the Covid Era Recedes in Rearview Mirror

We like to point out that as a financial asset, bitcoin has two important attributes that make it valuable in the context of portfolio construction: high risk-adjusted returns (see below) and low correlation with other asset classes. These attributes allow bitcoin to contribute to portfolio returns, while at the same time reduce overall risk. However, over the past 3 years, one of those attributes, bitcoin’s risk-reduction capabilities, has come into question as correlations with equities soared. While today bitcoin’s correlations with equities are on the decline, it is important to unpack the history of bitcoin’s correlations so that we might better understand where it may go in the future.

One of the key learnings is that bitcoin has had 2 distinct eras of correlations, before the monetary and fiscal response to the Covid-19 healthcare crisis (BC) and after the response to the Covid-19 healthcare crisis (AC). The BC era was characterized by essentially zero correlations with equities as well as every other major asset class. We focus on bitcoin’s correlations with equities (the S&P 500 Total Return index) simply because risk in most portfolios stems from equity exposure, and thus it would be the most beneficial for investors to diversify away from. We use a 3-month rolling correlation to acknowledge that correlations are not static and that we may learn something from the peaks, troughs, and averages rather than one long-term measure.

As we can see in the following chart, bitcoin’s BC era (highlighted in orange) was characterized by weak correlations at the peaks and troughs, meandering from +0.4 to -0.3, and averaging to essentially 0.0. Bitcoin’s correlation to other asset classes looks very similar in this era.

Weekly 5-Jun-02-2023-04-42-51-9227-PM

However, as we can see from the AC era, the yellow box above that starts with the March 2020 fiscal and monetary response to Covid, bitcoin experienced a completely different correlation dynamic with equities. We would characterize this era as elevated, peaking at nearly 0.7, but staying positive the entire time with an average of 0.4, well above the BC era average of 0.0.

But it wasn’t just bitcoin’s correlation to equities that changed. Its relationship to most other asset classes experienced a change in state. The following chart illustrates the change bitcoin experienced with equities, gold, and the US dollar, which we would describe as having higher highs, lower lows, and higher absolute averages.

Weekly 6-Jun-02-2023-04-42-38-8274-PM

What are we to blame for this change in state? Our guess is the jump in global money supply because of stimulative actions from central banks (monetary stimulus) and governments (fiscal stimulus) around the world. That time saw a marked increase in M2 money supply, but also a collapse in the velocity of money. Said differently, much of the money printed in that era likely went into financial assets (bitcoin, stocks, bonds, gold, etc.) and capital investments (homes), rather than the consumption of goods and services that drive GDP. Naturally, pushing this money into financial markets all at once would increase the correlation between those assets, hence the elevated state of bitcoin’s correlations with stocks.

Weekly 7-4

Now that the AC era is ending, will bitcoin’s correlations go back to zero? The answer to this question is not clear, but the question is an important one. Correlations are important inputs to weighting investments in the context of a mean-variance optimization (MVO) that underpins modern portfolio theory (MPT). On one hand, there’s the argument that bitcoin is increasingly in the hands of professional investors, who react to macroeconomic data and variables in different ways than the retail investors who historically dominated the asset class. On the other hand, we have found very little in terms of economic factors which can explain bitcoin’s price movements. Most factors have very little explanative power (low R-squareds) if significant at all. That is good for bitcoin’s diversifying power in the future – it means returns are likely driven by factors idiosyncratic to the asset class itself, such as ownership, usage, and adoption. Given that, our guess is that bitcoin’s correlations with equities revert to a similar state of the BC era of meandering about a mean, but one that higher than 0.0. Something between 0.0 and 0.3 makes sense to us as it takes into consideration that bitcoin is still largely driven by unique factors but acknowledges the investor base has changed. A correlation of 0.3 is not as powerful a diversifier as a correlation of 0.0 like bitcoin had been in the BC era, but it’s still extremely powerful in the context of portfolio construction.

Bitcoin’s Long-Term Returns Continue to Hold Up as Risk Declines

Over the past few weeks, we have highlighted bitcoin’s declining volatility (here and here). But given the connection between risk and return, we wondered what this declining volatility said about bitcoin’s returns. Volatility is the statistical measure often associated with an asset’s risk and one of the key inputs, along with returns and correlations, that underpin MPT. The key takeaway is that risk and return are connected, and with greater risk comes greater return (and vice versa). Our takeaway is that even as measures of risk, such as realized volatility and implied volatility, decline for bitcoin, long-term returns continue to hold up.

The annualized returns for rolling 3- and 5-year hold periods continue to show healthy returns. As of the end of May, the annualized return on holding bitcoin for 3 and 5 years was 41.6% and 29.2%, respectively. This includes the severe drawdown experienced in 2022. Furthermore, returns never dipped negative, save for one month in 2016 for the 3-year hold period. The amplitude of the rolling returns does seem to be narrowing, as bitcoin becomes a more mature asset.

Weekly 3-Jun-02-2023-04-37-56-5378-PM

Tying together both risk and return, the Sharpe ratio, a measure of return per unit of risk, is off the historical highs but continues to hold up. These measures do appear to exhibit some relationship to bitcoin’s price cycles, as do rolling returns. By comparison, the S&P 500’s 3- and 5-year Sharpe ratios were 0.65 and 0.50 respectively at the end of May.

Weekly 4-Jun-02-2023-04-38-06-3021-PM

Transaction Backlog Lingers Around the Highs, But Immediacy Drops

Bitcoin’s mempool, the backlog of transactions waiting to be stamped into blocks by miners, continues to hover around the Ordinals and BRC-20-induced highs. However, because of the declining demand for transaction immediacy, fee rates (satoshis/vByte) have begun to recede. Transaction fee rates are subject to the market forces of supply and demand, and with block space (supply) capped at 4MB/block, increases in demand, such as transaction volume and transaction immediacy can cause fee rates to rise.

Weekly 1-Jun-02-2023-04-26-43-7438-PM

Link to the Chart

To date, there have been nearly 10.5M inscriptions on Bitcoin’s blockchain paying $43.7M in fees to miners according to a Dune dashboard created by user dgtl_assets, an enormous uptake since launching in the middle of January. Daily new inscription volume does appear to be coming off the early May highs, which was driven by the BRC-20 meme coin craze. At the time of writing, the BRC-20 token still has a collective value of $475M according to the tracking website, an astonishing sum for a technology created less than 3 months ago.

Our final observations is that with the declining fee rates, daily transaction fees paid to miners have receded as well, although fees remain above their pre-Ordinals levels. Regardless of whether any one current application, be it BRC-20s or NFT art, has staying power, it is clear to us that the design space opened by Ordinals has unleashed a creative energy around building on Bitcoin that we have not seem in many years.

Weekly 2-Jun-02-2023-04-28-09-4332-PM

Market Update

Weekly 9-3

The price of bitcoin rose 1.5% on the week, snapping a 4-week losing streak. Bitcoin continues to be largely rangebound following stellar performance in 1Q, as investors look for new catalysts for the asset. Equities continue to rally, largely driven by the tech-heavy Nasdaq, which is up 25.7% year to date. On the week, the S&P 500 was up 1.7% while the Nasdaq Composite was up 3.2%. Gold rallied 1.8% on the week, while oil fell 2.4%. Bonds rose on the week with investment grade corporate bonds up 1.8%, high yield corporate bonds up 1.3%, and long-term US treasuries up 3.1%.

Important News This Week


Fidelity's Dir of Global Macro, Jurrien Timmer, on BTC Cycles & Adoption - Twitter

Fidelity's Timmer Looks Bitcoin Valuation and Asset Allocation - Twitter

Wall Street Prepares to Take on Established Crypto Companies - FT

Investment Bank Cowen's Digital Asset Unit is Shutting Down - The Block

Binance May Let Some Clients Keep Collateral in Bank Accounts - Bloomberg

Coinbase Derivatives to Offer Institutional BTC and ET Futures - CoinDesk

Regulation and Taxation:

Advisory on the Risks Associated with DCOs Clearing of Digital Assets - CFTC

Commissioner Johnson Calls for the CFTC to Initiate a Rulemaking Process for DCOs Engaged in Crypto or Digital Asset Clearing Activities - CFTC

CFTC Seeks Public Comment on the Risk Management Program Requirements for Swap Dealers and Futures Commission Merchants - CFTC

Former Coinbase Manager and His Brother Agree to Settle Insider Trading Charges Relating to Crypto Asset Securities - SEC

Just Two Exchanges Registered in Hong Kong as Crypto Ban Lifts - Protos


Tether USD₮ in Circulation Reaches All-Time High - Tether

Tether Invests in Energy Production and Sustainable Mining in Uruguay - Tether

Gemini Crypto Exchange Pivots After Layoffs, Losses, Earn - Bloomberg

Welcoming Transpose to Chainalysis - Chainalysis


Meet @Fiatjaf, The Mysterious Nostr Creator Who Has Lured 18 Million Users And $5 Million From Jack Dorsey - Forbes

Upcoming Events

June 13 - CPI reading

June 14 - FOMC rate decision

June 30 - CME expiry

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