TL; DR
1. BlackRock and Coinbase’s Partnership strengthens a positive institutional attitude
2. US macro recovery but inflation is pushing Fed to be more aggressive on raising interest rates
3. Bitcoin return is growing closer to US equity markets
4. Bitcoin return is strictly negatively correlated with US interest rates
5. Bitcoin return is sensitive to M0 changes rather than M1 or M2 in the US

1. Research Background

1.1 Institutional Preference

BlackRock Inc.(NYSE: BLK) announced its partnership with Coinbase Global Inc.(NASDAQ: COIN) on August 4, 2022, sending Coinbase shares rocketing that day. This partnership is a strong stimulus for the negative crypto market sentiment, hammered by falling prices and government investigations. As, BlackRock, the largest asset manager, is making it easier for institutional investors to manage and trade Bitcoin. The announcement fueled Coinbase shares to rocket for a few days and was eventually calmed by Coinbase's Q2 earnings. Nevertheless, this move is considered a leap in the crypto market as institutional investors are reaching in. 'The pact is a seismic shift in the crypto industry.' said Leah Wald, CEO of Valkyrie Investments.

Top BlackRock clients will gain access to Bitcoin through its Aladdin investment management system, making it easier to manage their exposure along with their stocks and bonds. And the focus 'will initially be on Bitcoin', BlackRock mentioned. BlackRock is the largest asset manager in the world, with 8.5 trillion USD under management by June 2022 and there are approximately 21 trillion USD worth of financial assets managed on Aladdin. According to Credit Suisse, the total wealth of the world by 2020 is 418 trillion USD, and the total asset on Aladdin counts for 5% of it.

1.2 Macro Recovery

The US economy added 528,000 jobs in July, beating estimates by 100%, and June job data is upwardly revised to 398,000. The biggest push in July was leisure and hospitality, particularly in food service and drinking. And the unemployment rate fell to 3.5% which is at historical low tying the pre-pandemic level. This is a strong showing of economic recovery. However, the skyrocketing inflation is still a huge hurdle for the Federal Reserve to cross.

Standing on this historical turning point of economic uncertainty, it is very important to review what history has taught us and move forward with the new forces in the crypto industry. In this study, we will examine the historical correlations of Bitcoin returns relative to other economic and market variables to show the way before and hope to gain some insights into the path ahead.

2. Method of Research & Data

Bitcoin market is more of a global market rather than a regional one. But in this research, we are focusing on the US economy as a starting point and would extend to other economies in the future. This research will adopt monthly data from Jan. 2015 to Jun. 2022. We are picking Bitcoin monthly returns as it is a better indicator and easier to compare to other variables, especially macroeconomic variables in this research. Correlations between all the variables will be calculated and different time frames will be selected to calculate the correlation in different time frames, in an attempt to see changes in different market conditions.

The following US macroeconomic data are selected:

It is important to state that any correlation found in this research does NOT indicate causation. The correlation only suggests the tendency of two variables to move together, and how deep that tendency is. Causation relations can only be inferred through further studies. All data used in this research is from the St. Louis FRED database.

3. Simple Correlation Analysis

3.1 Methodology

Simple correlation analysis would use all the data to calculate one correlation coefficient between any two variables. This analysis is to give a macro view of the relation between all the variables and serves as a benchmark for the following analysis.

3.2 Correlations & Analysis

The chart above shows the simple correlation coefficients between Bitcoin returns and other variables. There are three interesting facts we found:
1. Although the correlation coefficients are low in general, with a high of 0.27 and a low of -0.23, the coefficients are higher in certain market returns categories.
2. The correlation between Bitcoin returns and inflation for all urban consumers is near 0, and the correlation with inflation in food is significantly higher at -0.23. This is a good indication that the US money supply caused inflation, and the oversupply coupled with Covid encouraged a large number of individual indicators to purchase BTC during the Covid WFH period.
3. The correlation in the interest rate category is all negative, suggesting the risky nature of Bitcoin returns. This could be caused by strong interest moves by the Federal Reserve to control inflation.
4. Commodity market does not have an obvious relation with Bitcoin returns.

4. Annual Correlation Analysis

4.1 Methodology

Annual correlation analysis would divide each variable into different nature years and calculate the correlation within each year to find a progression of relations between Bitcoin returns and other variables. The changes in correlation coefficients would offer good insights into how Bitcoin returns progress over the years. We would also compare the annual correlation with the simple correlation from the previous section. And since we are still in the year 2022, we further examined the results with and without data from 2022 at the end of the section.

4.2 Correlations & Analysis

The figure above shows the correlation evolution between Bitcoin returns and major market index returns. As the figure shows, the trend varies over the years and is extremely unstable. However, the correlations are very close to each other until 2022. This could be explained by the lack of data in 2022 or the significant bear market or a bad macroeconomic environment. When we take a close look at this graph, the upward trend is very clear, especially before 2022. There is a growing tie between Bitcoin returns and major market indexes.

There is another characteristic of this graph when compared to the others, is that the lines are very tight together. This is caused by the high correlation between market indexes, around 80% of the equity market moves together.

The figure above shows the annual correlation between inflations and labor market statistics. Some clear trends can be observed:
1. The correlation between inflation and Bitcoin returns is dropping over the years, while the inflation in food and Bitcoin returns are slowly growing ties. This may suggest that Bitcoin is growing away from its digital gold definition and becoming more of a risky asset.
2. The correlations between Bitcoin returns and labor market statistics are all rising from 2015 to 2021 and dropping sharply in 2022, especially the correlation with the unemployment rate of people with bachelor's or higher degrees and ages over 25.

This figure shows the correlation trend between Bitcoin returns and money supply. It is clear that the correlation levels are rising through 2015 and 2021. The correlation peaked in 2021 and soon turned down in 2022. The downturn in 2022, could be just an adjustment of an upward trend, like many before. Or it is simply due to the lack of data in 2022. This trend also shows that Bitcoin's behavior resembles that of a risky asset, with a positive correlation to money supplies.

Figure 5 shows the correlation between Bitcoin returns and different interest rate levels. Similar to Figure 2, the lines are very tight and trending in the same downward direction. The downward trend of the figure is very clear and this is in line with what was found in previous figures that Bitcoin is behaving like a risky asset rather than a riskless one.

A simple economics lesson here. When there is too much money in the economy, the Federal Reserve would increase the interest rate to reduce liquidity. Less money in the economy would cause risky assets, like equities, to tank. Therefore, the correlation between the equity market and interest rate level is negative. When Bitcoin is negatively correlated with interest rates and positively correlated with the equity market, we could infer that Bitcoin is acting like a risky asset.

4.3 Annual Correlation Summary

The annual correlation coefficients summary is as follows:

As the table above summarizes, there are very clear trends between Bitcoin returns and most of the variables. However, all the trends shifted in 2022. As mentioned, this could be explained by the lack of data, since there are only 6 months of data in the sample. Or the strong Bear market is to blame for the shift. In general, Bitcoin is behaving close to a risky asset with a growing correlation with the US equity market.

5. Bull & Bear Correlation Analysis

5.1 Methodology

In this method, we would try to cut the data by bull and bear market conditions, and calculate the correlation between the Bitcoin returns and other variables in each market condition. In this method, we would like to explore the interactions in different market conditions. Since the definition of Bull or Bear market condition is not strictly defined, the division of data is subjective to our definitions and the conclusion is subject to personal view.

Our definition is as follows:

Bull market: when the BTC returns are in general positive and rising.

Bear market: when the BTC returns are in general negative and decreasing.

Figure 6 shows the monthly returns of Bitcoin for the past few years, and we will divide the Bull and Bear market as follows:

5.2 Correlations and Analysis

According to our bull and bear market division, the correlation between Bitcoin returns and market indexes is higher in bull markets and lower in bear markets. This finding suggests that Bitcoin returns are more in sync with stock market returns during bull runs and less in pace during bear markets.

The Correlation between money supply and Bitcoin returns is not uniform, suggesting the money base is more closely related to Bitcoin returns than M1 and M2 during different market conditions.

Figure 9 shows the evolution of Bitcoin as an asset. During the first bull market, the positive correlation suggests Bitcoin is more like a riskless asset. However, as Bitcoin evolves over the market condition, it is gaining the attribute of a risky asset, rather than a riskless one.

As we mentioned at the beginning of this section, the definition of bull and bear markets is not strict. We made our definitions and based our analysis on them. The results in this section are not to be inferred as investment suggestions.

6. BTC Returns Volatility Comparison Analysis

6.1 Methodology

In the previous analysis, we have established that Bitcoin returns are growing more positively correlated with major US equity market indexes. In this section, we will explore the volatility of Bitcoin compared to the US equity market indexes. We will calculate the standard deviation to quantify volatility for each year. The higher the standard deviation is, the greater the volatility is.

6.2 Volatility

The figure above shows the volatility levels over the years. We can clearly see that Bitcoin volatilities are significantly higher than that of the equity markets. This is enough to say that Bitcoin is a risky asset with high volatility.

Another interesting discovery is that equity market returns volatility is raising from 2017 to 2020, but Bitcoin returns volatility is dropping. Combined with the growing correlation, this is showing some level of convergence between the Bitcoin market and the major US equity market.

7. Conclusion

Bitcoin and blockchain technology, with their growing impact and technical capability, are gaining more and more attention around the world, and BlackRock is just the latest of many. This study, as mentioned in the beginning, is a simple recap of how Bitcoin has evolved in terms of relations with the market and economic variables over the years. There were many ups and downs, and so will the future. What has not changed is our faith in this technology and its bright future.

There are some simple conclusions that we can draw from this study:
1. Bitcoin is growing more closely to an equity-like risky asset with a high positive correlation with the equity markets and a negative correlation with interest rates.
2. Bitcoin returns are more sensitive to monetary base changes rather than M1 or M2.
3. Bitcoin returns are negatively correlated to inflation but positively correlated to inflation in food.
4. Bitcoin returns are more closely related to equity markets during bull runs.
5. Bitcoin returns volatility is significantly higher than that of the major US equity markets which means Bitcoin is far riskier.

Disclaimer

* This article represents only the views of the observers and does not constitute any investment suggestions.
* Gate.io reserves all rights to this article. Reposting of the article will be permitted provided Gate.io is referenced. In all other cases, legal action will be taken due to copyright infringement.


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Gate.io Team
October 21