New Report Shines Light On Crypto Volatility

The Risk Protocol (TRP), is a specialist investment platform focused on mitigating some of the risks associated to investing in cryptocurrencies. Its new report ‘The Nature of the Beast,’ examines cryptocurrency volatility as well as the statistical characteristics of returns for the top 50 cryptocurrencies – with the ultimate aim of accurately forecasting volatility across the industry.

TRP founder Karamvir Gosal says the motivation for the research was to reliably price a range of TRP investment products. He says existing research on crypto volatility was typical undertaken through the lens of traditional finance, “making the grand assumption that the underlying nature of crypto returns was similar to traditional equity market returns.” He says while that was true in some cases, crypto’s behaviour was often distinctly different.

Key findings included:

• Unlike equity markets, cryptocurrencies do not consistently exhibit a ‘leverage effect,’ the phenomenon that an asset’s volatility is negatively correlated to its returns. For traders this could have major implications as they cannot necessarily hedge long underlying crypto exposure by being long volatility. In fact, such a strategy could double a trader’s downside exposure if the underlying crypto is one that exhibits an anti-leverage effect.

The calendar effect with crypto is persistant and distinct. Source TRP

• The ‘calendar effect’ with cryptocurrencies is significant, with ‘day of the week’and ‘hour of the day’ pattens being persistent and distinct. For traders, this means effective trading and investment strategies can be created around the best inter and intra-day periods for buying and selling volatility as well as entering or exiting trading positions.

• Bitcoin and Ethereum having the highest correlation at 0.872 and the rest of the top 50 cryptocurrencies exhibit material correlation (average 0.524). The LEO token, however, is a major outlier in correlation terms at 0.013. Given the controversial past of both Bitfinex and Tether (entities affiliated with LEO), this warrants further investigation.

• Cryptocurrency volatility patterns are similar to other financial assets, but they behave more like equities than currencies.

• Cryptocurrencies exhibit gain/loss asymmetry, meaning it usually takes less time to drop a certain amount than it takes to move up by the same amount. Again, this is similar to equities and in contrast to currencies, which exhibit greater symmetry in up/down moves.

The annual correlation between BTC and the U.S. Dollar Index reached a very significant -0.75 level which supports the popular narrative that if the US dollar slides, one could expect BTC returns to be stronger, with its negative correlation to the dollar.

Cyptocurrency returns have a non-normal distribution, are fat tailed and exhibit a greater likelihood of extreme events. That said, the standard deviations vary widely across the cryptocurrencies analyzed, ranging from 76% for LEO to 338% for MANA (Decentraland).

Interestingly, prior to 2020 and the Covid related slump, there was no significant correlation between Bitcoin and broader equity markets. However, the correlation has become significantly positive since then, especially between BTC and Nasdaq.

Cryptocurrencies and the broader US stock market exhibit significant volatility spillover, especially in recent years and in some of the more mature cryptocurrencies. TRP’s hypothesis is that this spillover is unidirectional, in that volatility in traditional financial markets has an impact on crypto markets volatility, however volatility in crypto is self-contained and does not flow into traditional finance.