As the cryptocurrency market steadily evolves into a more mature state, hedging will become more valuable. This process is reducing the correlations between the top 20 cryptocurrencies, up to the point where they are lower than the norm for same sector stocks in equities.
The chart below shows Bitcoin’s correlation with the next 19 cryptocurrencies for 2017. There is only one above 0.5 — Monero. Statistics define correlation coefficients between 0.3 and 0.5 as low and can even sometimes be rendered insignificant. The results may be surprising, but they confirm what we just stated — correlations are decreasing as the market matures and single cryptocurrencies find their own path. For comparison, stocks in the same sector tend to be highly correlated as they are exposed to the same macro-economic factors.
Aren’t cryptocurrencies in the same “sector”?
This is a very controversial topic, but the truth is that, while cryptocurrencies all use blockchain technology and are in essence digital assets, they have very different purposes and functions. Just by looking at the names in the correlation chart, we can see how different the top 20 cryptocurrencies are from one another. Some serve purely as a store of value, others provide digital infrastructure and some are finance-related. Therefore, it becomes obvious that correlations are bound to decrease as these digital assets have very distinguishable features. Comparing Ripple with Bitcoin is like saying BMW and Apple are similar companies because they trade on the stock market.
What do these correlations tell us?
The lower the correlation within a sector, the higher the diversification factor when constructing a portfolio. All of this means that trading an index like Rhea’s Crypto20 is superior to trading individual cryptocurrencies. This can be proven by analyzing historic returns on different portfolios (which we will not get into), which proves that diversification is the best way to beat the market in terms of risk-adjusted returns.
The Crypto20 offers a basket of digital assets with weights set according to their respective market capitalization. Trading it will greatly reduce the implied volatility when compared to an equal-weighted portfolio or a selection of a few cryptocurrencies.
How can you trade the Crypto20?
Rhea’s trading platform will allow investors to trade the Crypto20 index via options — one of the most flexible financial derivatives. This will unlock new possibilities in the crypto world by giving access to a diversified portfolio of cryptocurrencies. In addition, cash-settled options make the entire process as easy as possible, because no transfer of digital assets will be necessary.
Options also provide protection against downside risk (when prices fall) through long puts and short calls. Both of these yield a positive return when an asset’s price is trading below its strike at expiration — the perfect tool for a bearish view. Investors can keep their individual cryptocurrencies in their digital wallets without having to resort to fire sales when prices fall.
Another great benefit of options is the ability to take short positions. Investors with a bearish view can easily exploit a market correction — a very popular strategy in finance, which will be made available for the first time in cryptocurrencies by Rhea.
Taking things into perspective, options trading on an index is far superior than on any individual asset, because of diversification. As previously explained, cryptocurrencies have very different applications and features — a fact which renders “stock-picking” very hard. Trading the Crypto20 gives investors immediate and low-cost access to a perfectly balanced and well-diversified portfolio.
Rhea’s vision with regards to options trading is to develop a sophisticated platform, with a wide choice of indices and option specifics available to investors. Rhea’s ICO starts on October 2nd. To find out more about the features of the options trading platform visit Rhea’s website.
