Fact CheckedLast Updated on February 18, 2024 by Stephan Lindburg
Cryptocurrencies have surfaced as a transformative influence in the financial industry. They have introduced a decentralized, borderless, and transparent system of value exchange. As the crypto market continues to mature, investors and traders are increasingly turning their attention to understanding the factors that affect crypto prices. Cryptocurrency correlations are the degree to which the prices of various cryptocurrencies move in relation to each other. This is an important concept to master as it can inform traders what moves they need to make. In this article, we will look at cryptocurrency correlations and how they can help us make trading decisions in the market.
Understanding Cryptocurrency Correlations
Contents
Cryptocurrency correlation is the measure of the extent to which the prices of two or more crypto assets move in relation to one another. These correlations can be positive, negative, or neutral, indicating the strength and direction of the relationship. A positive correlation means that the prices of the assets tend to move in the same direction. Contrarily, a negative correlation implies movement in opposite directions. Neutral or zero correlations suggest a lack of consistent relationship.
Correlations can change over time due to various factors. These can include market sentiment, regulatory developments, and technological advancements. Analysing these correlations can provide valuable insights into the dynamics of the cryptocurrency market and inform trading decisions. In other words, it can give traders an edge in the market especially when they use this knowledge alongside other trading tools. When people trade crypto on TradingView, they can use the tool to analyze how the prices of different assets move in relation to one another. Below are some notable cryptocurrency correlations that exist.
Bitcoin and Altcoins
Bitcoin often sets the overall tone for the cryptocurrency market. When Bitcoin experiences significant price movements, it tends to have an impact on many altcoins. However, individual altcoins can also have unique factors influencing their prices. In general, Bitcoin’s price often has an inverse correlation with altcoins. When Bitcoin is performing well, altcoins may struggle, and vice versa.
Ethereum and ERC-20 Tokens
Ethereum is the leading smart contract platform that hosts a plethora of dApps. Understandably, the Ethereum cryptocurrency has a strong correlation with tokens built on its blockchain (ERC-20 tokens). The success and adoption of Ethereum can positively influence the prices of associated tokens. This is because they completely rely on Ethereum’s infrastructure.
Binance Coin (BNB) and Binance Smart Chain (BSC) Tokens
Binance Coin is the native cryptocurrency of the Binance exchange and blockchain. Similarly to Ethereum, BNB is closely tied to the success of the Binance Smart Chain tokens. BSC-based tokens exhibit a correlation with BNB as they run on Binance’s platform.
Privacy Coins
Privacy-focused cryptocurrencies like Monero (XMR), Zcash (ZEC), and Dash (DASH) may exhibit correlations with each other. Investors interested in privacy features may diversify their holdings among these coins. This can lead to similar price movements between these different assets.
DeFi Tokens
The correlation of different DeFi tokens is similar to what we see with privacy coins. Decentralized Finance (DeFi) tokens often have positively correlated price movements. These include crypto assets such as Uniswap (UNI), Aave (AAVE), and Compound (COMP). They are part of a broader trend in decentralized finance and any development in the space can lift multiple tokens at the same time.
Interoperability Coins
Cryptocurrencies focused on interoperability usually have a correlation due to their similar goals of connecting different blockchains. These include crypto projects such as Polkadot (DOT) and Cosmos (ATOM). Positive news or partnerships within this space can impact both coins.
Cross-Platform Tokens
Some cryptocurrencies aim to provide cross-platform compatibility and interoperability. These include projects like Chainlink (LINK) and Thorchain (RUNE). They may have correlations due to their shared mission of connecting different blockchain ecosystems.
Stablecoins
Stablecoins like Tether (USDT), USD Coin (USDC), and Binance USD (BUSD) are designed to maintain a stable value. They often have a high correlation with each other. However, they usually have a negative correlation to other cryptocurrencies. This is because they usually act as safe havens during times of market turmoil. Market volatility may take money from other unstable cryptocurrencies into stablecoins to maintain value.
How Can Cryptocurrency Correlations Help Us?
Understanding cryptocurrency correlations can be beneficial for crypto traders in several ways. Here are some ways in which understanding these correlations can help crypto traders:
Strategy Optimization
Strategy optimization is probably the most helpful thing that can come from understanding cryptocurrency correlations. Traders can optimize their trading strategies by considering how different assets move in relation to one another. For example, if a trader uses a momentum strategy, understanding the correlations between different cryptocurrencies can help in selecting assets that are likely to move together.
Risk Management
Correlations can provide insights into the risk associated with holding a particular cryptocurrency. If two cryptocurrencies have a high positive correlation, it means they tend to move in the same direction. Diversifying a portfolio with assets that have lower correlations can help reduce overall risk. Essentially, a trader should avoid having assets that could fall in price at the same time.
Market Sentiment Analysis
Understanding correlations can help traders gauge overall market sentiment. If most cryptocurrencies show a strong positive correlation, it might indicate a market-wide trend or sentiment. Conversely, low or negative correlations may suggest varied market conditions.
Hedging Strategies
Traders can use knowledge of correlations to implement hedging strategies. For example, if there is a negative correlation between two assets, holding both in a portfolio could provide a natural hedge against losses. When one asset falls, the other may rise and neutralise the losses.
Market Timing
Correlations can be used to identify potential market turning points. For instance, a historically high positive correlation between Bitcoin and altcoins may change during specific market conditions, providing traders with insights into potential shifts in market dynamics.
Volatility Assessment
Understanding correlations can help traders assess overall market volatility. More money flowing into stablecoins can indicate higher market volatility and vice versa. Understanding these correlations can help traders decide where they want to direct their money.
Conclusion
Cryptocurrency correlations provide a valuable lens through which investors can analyze market dynamics, manage risk, and optimze their strategies. However, correlations may shift with time due to plenty of factors in the market. Investors who understand these correlations even when they change gain a competitive edge in navigating the ever-changing cryptocurrency market. Evidently, understanding cryptocurrency correlations is an essential tool for any investor seeking success in crypto trading. It can aid in shaping trading strategies, diversification, risk management, and sentiment analysis.