Investigating the correlation and cyclicality of cryptocurrencies

The correlation between the dollar value of the main cryptocurrencies constantly fluctuates due to factors such as: the irrationality of the market, closely linked to the so-called "herding effect", and the phenomenon of co-movement.

Herding effect” refers to a financial phenomenon that is particularly evident starting from the 2008 crisis that represents an individual's tendency to replicate the actions of a larger group of investors, regardless of whether these choices are rational or not.

The phenomenon of co-movement refers to the particular correlation that is currently present among the different cryptocurrencies. It is in fact usual that the value of different cryptocurrencies perform movements synchronized positively or negatively, a symptom of a strong correlation between different assets.

Taking a cue from the latest report published on 11 April 2019 by the famous exchange Binance, in this article we present 3 peculiar characteristics of the cryptocurrency market that can help to have a greater understanding of the entire market.

1. The turning points of the market and the cyclical nature of the correlation

The graph below shows the average correlation (expressed in USD) among all cryptocurrencies, obviously excluding the stablecoins.

As can be seen from the graph, when the correlation between these currencies reaches high positive values (from 0.8 to 1.0), it can be seen that Bitcoin tends to reverse its trend, or at least interrupt the previous trend.

This would suggest an end to the downtrend encountered during 2018.

The table below shows the periods of time in which the cryptocurrency market has reached a correlation level higher than 0.8

Since 2014, these periods of high correlation have lasted on average 39 days. The current high correlation cycle began on December 15, 2018 and ended on March 14, 2019, for a period of 90 days, the longest period of correlation during the history of cryptocurrencies.

2. Very high portion of private investors

According to data published by, approximately 700 institutional investment funds are dedicated to the cryptocurrency market for a total of assets of less than 10 billion dollars.

Assuming that these investment funds only own Bitcoins, their assets would only count for 14% of the total value of the Bitcoin market. Assuming instead a portion of altcoin in their portfolio, the share of the attributable market controlled by institutional investors could fall below 7%.

The 7% estimate for the market share attributable to an institutional participation would be equal to a thirteenth compared to the share of institutional participation in the American stock market.

Investigating among the traditional financial markets, the only structure that somehow refers to the composition of the cryptocurrency market is the Chinese stock market. For the latter, in 2017, the number of accounts linked to private investors consisted of 99.8% of the total, having more than 40% of the market value and representing about 80% of the trading volume.

Another analogy between the cryptocurrency market and the Chinese stock market is the very high market yield.

As shown in the graph below, the markets dominated by a strong presence of private investors (such as the crypto market and the Chinese stock market) tend to have a higher rate of return (calculated as an annual volume divided by the total of equity contracts).

The annual performance of the cryptocurrency market (calculated with the adjusted volumes present in the database coinmarketcap.comamounts to 2150% up to 2018, 6 times higher than the US stock return and 3 times higher than the Chinese stock return.

This figure also indicates that investors in the cryptocurrency market (Calderòn 2018) are moved more by information and news, and at the same time hold positions for a shorter period of time than equity markets.

In general terms, private investors are much more inclined to develop extremely confident or extremely pessimistic feelings as a reaction to market movements. This approach potentially leads to higher trading volumes and more volatile prices, as already highlighted by some studies (Kent Daniel and David Hirshleifer 2015).

However, the market is still too young to draw conclusions about cryptocurrency investor behavior. In fact, in a market that is still in its infancy, cryptocurrency investors appear to be very active and wait for new market developments. Also bearing in mind that individual investors play a central role in the success of the entire market and are therefore encouraged to make their voices heard even if only through price dynamics.

3. HODL-ing: a unique feature of the crypto market.

During market downturns, unlike in other markets dominated by sentiment, rather than liquidating the entire portfolio, many investors in cryptocurrencies prefer to do "HODL" despite the prolonged fall in prices.

Fun fact: HODL derives from "Hold", literally "hold", it is a term that refers to the prolonged holding of an asset regardless of its market trend since it is aware that in the long run the price will tend to rise in a huge way.

The term was born in a completely random way in 2013 in a Bitcoin Forum post in which a user declared "I AM HODLING" in reference to a particularly unfavorable market period. The term HODL has over time become a slogan of the crypto culture that refers to that desire not to look at market movements in the short term, but instead aims at the strong accumulation of crypto currencies even in bearish periods with a view to a strong return in the long run.

The "HODL" phenomenon can be observed from the "realized cap" introduced by Antoine Le Calvez and Nic Carter, often referred to as "UTXO (Unspent Transaction Output) market cap".

Graph 4 shows how crypto investors tend to do HODL during bear market periods.

This attitude can also be confirmed by Calderòn's research (2018), which shows a greater "herding effect" during bull market periods (price increase) and a greater inclination to HODL during bear market periods (price decrease).

Finally, the effect of price shifts on the main cryptocurrencies (Bitcoin and Ethereum) has repercussions on the rest of the market mainly because most of the altcoins are exchanged only with other cryptocurrency pairs (which in most cases are BTC and ETH) ; this phenomenon, in addition to the aforementioned "herding effect", therefore corresponds to a tendency of:

  • Extreme market optimism that tends to increase the price of all cryptocurrencies (including those that do not have a clear utility or value).
  • Extreme market pessimism that often tends to significantly decrease the price of all cryptocurrencies (including those with clear utility and value).

Unlike the traditional financial market in which a high institutional presence and a more accentuated level of sophistication can be seen thanks to the presence of numerous derivative instruments, the cryptocurrency market is a much more susceptible market that has had to face problems such as:

  • Incomplete regulatory systems
  • Information asymmetry
  • Arbitrage

These peculiarities translate into a much more dynamic and sudden cryptocurrency market in price changes than stock markets, making it difficult to accurately predict. This demonstrates the fact that the herding effect is not to be attributed solely to the behavior of individual investors, but that it also derives from a market that is still very young with developing infrastructures.

However, during 2018, despite the constant drop in the market, we have noticed a growing interest from institutions and media towards the cryptocurrency market.

The market is experiencing a moment of rapid maturation that has already attracted new investors and begins to enjoy the support of governments and institutions. The development of clear regulations, increased data and reliable information, the reduction of usability frictions are already leading to a more rational discovery of the value of the entire market.

The table below summarizes the significant progress made over the last four months. Since the launch of many financial products that expand the market horizon to the development of clear legal schemes, the cryptocurrency market is maturing at an extreme speed.