Bitcoin's correlation with other digital currencies has declined. What does this mean?

Bitcoin (BTC) used to be the dominant digital asset, however, its share of the total cryptocurrency market cap has recently declined. From standing at around 70% at the start of the year, it has since fallen to less than 50%, highlighting how other digital assets have increasingly begun to capture a larger share of recent gains.

The logical extension of this decline in dominance is that the relationship between Bitcoin and other digital currencies is also beginning to decline. A year ago, almost all of the leading digital assets were pegged to Bitcoin with a value of 0.9 and above (1 being the maximum), but in recent weeks that number has fallen to less than 0.3 for many of the top ten cryptocurrencies.

Analysts' opinions on this decline are mixed. While some claim it is a temporary result of an expansive bull market, others say the diminishing correlation represents a fundamental shift in the industry, as other cryptocurrencies beyond Bitcoin increasingly prove their value propositions to investors.

We've already seen this

If you go back to the end of April 2020, Ethereum (ETH), Ripple (XRP), Dogecoin (DOGE), and Cardano (ADA) were all closely correlated with Bitcoin with ratios of 0.95, 0.92, 0.91 and 0.95, respectively. Basically, as the price of bitcoin goes up or down, they are all affected in the same way, as their movements are arguably little more than an expression of bitcoin's performance.

As the chart below shows, things started to change in the second half of the year.

Source: Coin Metrics

There was a gradual decline until July/August, when the price of Bitcoin (and to a lesser extent, Ethereum) began to rise, leaving many altcoins behind. Despite the recovery in relations in October, things started to fall again from November, when Bitcoin's bullish rally was already starting to gain momentum.

Again, there was a partial recovery in January of this year, but the interrelationships have been declining sharply since February. That's exactly when many altcoins started to make up for lost time, and prices shot up as many rookie investors searched for the next big thing (now Bitcoin might seem a bit expensive).

“The weak correlation between Bitcoin and other major currencies in a bull market is nothing new. “Because Ethereum and cryptocurrencies rise during bull runs, they often generate higher returns than Bitcoin, which in turn leads to a lower correlation,” said Robbie Liu, market analyst at OKEx Insights.

The same phenomenon was largely observed during the 2017-2018 rally, Liu noted. “The most notable example was in January 2018, when the correlation coefficient between Bitcoin and Ethereum dropped from above 0.8 to a negative value,” he told Cryptonews.com.

Almost every analyst would agree that the decline in correlations is largely a product of the current bull market.

“In the 2017 bull market, bitcoin led the pack early on, but as investors gained confidence in the longevity of the boom, they increasingly looked to invest in smaller cryptocurrencies, which are beginning to drive these prices higher faster than bitcoin,” he said. Glenn Goodman, digital asset analyst and author of The Crypto Trader, “It's the same story back in 2021.”

Is it different this time?

Opinion is divided as to whether this decrease in correlation is permanent or temporary.

“Market participants are learning that many cryptocurrencies offer different value propositions. This became even more apparent when we started to see the evolution of the field highlighting these differences,” said Joel Krueger, Trader and Strategist at LMAX.

However, for other analysts, the "value proposition" mostly indicates the potential for a quick profit.

“What we're seeing now is an oversubscribed market. There is an excess of liquidity. Community members and supporters are buying some altcoins thinking it will give them 10-20x [return on investment],” crypto advisor and investor Andy Lien said, adding that many investors likely believe that Bitcoin has reached its maximum price level in the current period. .

Of course, the truth often lies somewhere in the middle. For Quantum Economics analyst Lou Kerner, the current bull market overheating is a big factor in the rise of altcoins, but it certainly isn't the only one.

Implications for Traders and Investors

No matter how long the shift continues, analysts agree that it is beneficial for traders and investors, since decreasing correlations offer them the opportunity to diversify.

“The decline in correlation should be a welcome development as it opens up more opportunities to trade in the different value propositions within the emerging space,” said Joel Krueger.

R takes a very similar position, saying that lower correlations provide smaller traders with a greater chance of making big gains.

Assuming divergence in interrelationships persists in the future, this will ultimately be a win-win for traders, investors, and the broader industry alike.

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