Digital Gold or Fool’s Gold: Is Crypto Really a Hedge Against Equity Risk?

Cryptocurrency enthusiasts often claim that digital currencies and tokens are uncorrelated with stocks and can provide a safe haven amid stock market crashes. The assumption is that crypto assets will act as “digital gold,” serving as a hedge against equity risk and helping investors weather such downturns.

Such bold claims beg for scrutiny, especially amid what appears to be a bear market for stocks. Therefore, we explore how crypto has behaved during previous crashes. In particular, we isolate major panic events over the brief history of cryptocurrencies and study the correlation between this new asset class and some of its more traditional peers.

Five times in the past five years, the S&P 500 has fallen 7.5% or more. In each of these cases, we measure how the correlations between gold and the S&P 500, bitcoin and the S&P 500, and bitcoin and gold changed. We examined correlations between other cryptocurrencies and gold and the S&P 500, but found that the results were qualitatively similar, so we used bitcoin as a proxy for cryptocurrencies in general.

The correlation between gold and the S&P 500 turned out as expected. Outside of major recessions, gold and the S&P 500 have only a slight positive correlation of 0.060. However, when the S&P 500 plunges, so does its average correlation to gold, which falls to -0.134. The bottom line is clear: Gold offers some protection in bear markets and lives up to its perennial hedge status.

Shock Correlations: Gold and the S&P 500

The same cannot be said of bitcoin, or crypto in general. Outside of stock market downturns, bitcoin and the S&P 500 have had a slight positive correlation of 0.129. However, in the midst of the last five stock market contractions, the correlation between bitcoin and the S&P 500 jumped to 0.258. In fact, in only two of the last five recessions has the correlation turned negative. On the other hand, true to its reputation for hedging, gold has been negatively correlated to the benchmark in four of the last five declines.

Shock Correlations: Bitcoin and the S&P 500

But what about bitcoin and gold? How has that relationship changed during recent panics and recessions? In rising stock markets, bitcoin and gold have a slight positive correlation of 0.057. Amid stock market declines, the correlation increases only slightly to 0.064.

So whatever the state of the stock markets, the correlation between gold and bitcoin is pretty close to zero.

Shock Correlations: Bitcoin and Gold

Based on our data, crypto certainly it’s not act like digital gold. In times of panic, the correlation between cryptocurrencies and the stock market increases. So, whatever their proponents say about their usefulness as a hedge against market downturns, cryptocurrencies have served more as an anti-hedge, with their correlation to the S&P 500 rising as stocks plunge.

That being said, given the lack of correlation between gold and cryptocurrencies, the latter can add some diversification benefits to a portfolio.

However, the overall verdict is undeniable: when it comes to hedging stock risk, bitcoin and cryptocurrencies are more of a hogwash than digital gold.

If you liked this post, don’t forget to subscribe to the Entrepreneurial Investor.

All messages are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.

Image Credit: ©Getty Images/Moonstone Images

Professional Learning for CFA Institute Members

CFA Institute members are empowered to self-determine and self-report professional learning (PL) credits earned, including content in Entrepreneurial Investor. Members can easily register credits using their online PL tracker.