Cryptocurrencies

Decoupling ahead? Bitcoin and Ethereum May Finally Break Their 36-Month Correlation

Anish Saxena, a New Delhi-based car dealer, made “incredible” returns investing in cryptocurrencies in 2020, just as his business was hit by the coronavirus pandemic-induced lockdown.

“He knew about Bitcoin and Ethereum and dozens of other assets for years,” said the 33-year-old businessman. “But I was only able to invest in them after the closure pushed me and my family members out of work. And it helped us survive in a big way.”

Anish revealed that he had allocated around 80% of his investment portfolio to Bitcoin (BTC) and Ether (ETH) with the rest of his capital distributed in Polygon, Dogecoin (DOGE) and Chainlink (LINK). His investment in cryptocurrencies alone brought him huge returns, the figures of which Anish refused to reveal.

However, he noted how he almost made half of his unrealized gains by deciding not to liquidate before the crash of May 2021.

“I was liquidating cryptocurrencies based on my household’s demand for cash,” Anish said. “While I still have a profit, seeing my profits decrease by more than 50% has led me to recoup a large part of my investments in cash.

Correlation risks

Retailers like Anish have come under pressure due to over-reliance on two of the leading and popular cryptocurrencies – Bitcoin and Ether.

While they are different in terms of economics and use cases, both digital assets tend to move in the same direction. In recent history, their profit and loss seemed to be well timed, illustrating that their holders can see their investments grow rapidly during uptrends but at the same time risk losing a lot when the uptrend is exhausted and reverses to the bearish side.

“If it’s a pure crypto portfolio, then of course having two cryptocurrencies that are highly correlated with each other adds risk to the portfolio,” said Simon Peters, a crypto analyst at multi-asset brokerage firm eToro.

“While the portfolio could perform exceptionally one month with the two cryptocurrencies making gains together, it could also see big declines in a bad month as the cryptocurrencies go down together.”

The correlation made between Bitcoin and Ethereum rarely fell below 50% in the previous three years. Source: Skew

On the other hand, Liam Bussell, head of corporate communications at fiat-to-crypto gateway provider Banxa, called for liquidity backups of Bitcoin and Ethereum for cryptocurrency traders.

In his comments to Cointelegraph, the executive said that traders use their initial earnings in the two major cryptocurrency markets to invest in low- and mid-cap digital assets, citing rallies in Dogecoin and non-fungible token projects. He noticed:

“Once the market starts to slow down, traders try to go back to liquid assets like BTC and ETH. This may offset declines for a short time, but it cannot hold the market indefinitely. Profits can be made in bear markets, but they are volatile currencies and the risk is high. “

Bitcoin and Ethereum trends throughout history. Source: TradingView.com

Additionally, Peters advised traders and investors to hedge the risks of their cryptocurrency investments by allocating a good portion of their capital in traditional financial instruments, including stocks, commodities, and fixed income securities / funds.

“Historically, cryptocurrencies have been shown to have no correlation with other asset classes and offer better risk-adjusted returns,” explained the analyst.

Decoupling ahead?

Peters, meanwhile, recalled that the transition from proof-of-work to proof-of-stake Ethereum network, known as Ethereum 2.0, could limit its correlation with Bitcoin.

In detail, one of the main features included in the next Ethereum blockchain update is deflation. Dubbed as EIP-1559, the Ethereum upgrade proposal is intended to burn off a portion of the transaction fees charged to users.

That could remove at least a million ETH tokens each year from the circulating supply, making the asset more scarce. according to crypto education publication Coinmonks.

Bitcoin exhibits a similar shortage by cutting its newly issued supply rate in half every four years, a process called halving. The cryptocurrency has a limited supply limit of 21 million tokens.

Related: London Fork Enters Ethereum Testnet As Difficulty Bomb Slows Down

“A decoupling between bitcoin and ether is possible after the completion of the transition to 2.0 as the ‘tokenomics’; the way ETH works on the blockchain 2.0 will be different than it is today,” Peters said, and added that:

“The demand for ETH could vary depending on the returns of the rewards at stake at the time, which in turn could drive the price of ETH higher or lower regardless of other cryptocurrencies.”

As for Anish, the novice trader said he would “HODL” a portion of his BTC and ETH.

“If the business recovers again after the full reopening of the economy, I plan to consistently invest in Bitcoin, Ethereum, gold and mutual funds,” he noted.

The views and opinions expressed here are solely those of the author and do not necessarily reflect the views of Cointelegraph.com. Every investment and business move involves risk, you should do your own research when making a decision.