Bitcoin is all the rage these days. It's a decentralized form of payment. Proponents argue for the benefits of having a currency free from the influence of governments and other large orginizations. They see it as a pure form of supply and demand in currency form.
Others have warned of the dangers of investing too much in the hype. Many of the old school investors are skeptical. Including the world's third richest man.
"If I could buy a five-year put on every one of the cryptocurrencies, I'd be glad to do it but I would never short a dime's worth."
-- Warren Buffet
Initial Analysis
In this post we hope to stay out of this debate. Instead we just wanted to do some exploratory analysis of the relationship bitcoin might share with different established markets.
Many of the skeptical investors beleive that bitcoin and other cryptocurrencies behave even more speculatively than currencies. We hope to investigate if there is truth in this claim.
To do this we will compare bitcoin with the Dow Jones Industrial Average (DJIA), gold prices, and the Euro. We chose these to compare bitcoin to because they are indicators for the US economy, commodity markets, and currency markets respectively.
Individual Investigation
We then took a closer look at each of the indivdual indicators compared to bitcoin. This allowed us to get more direct comparrison.
The first comparison we made was between Gold and Bitcoin. Once we normalized all the values we were able to see that Gold shares almost no correlated price movement with Bitcoin.
Next we compared Bitcoin to the DJIA. This showed a completely different relationship with Bitcoin compared to Gold. These two seem to move together. Their price movements are very heavily correlated.
Then we finished up by comparing the EURO with Bitcoin. The EURO turned out to be even less corrlated with Bitcoin than Gold did.
Volatility
After seeing if Bitcoin's movement was correlated with any of the indicators, we also wanted to examine the volatility in each of these markets. Bitcoin being a newcomer to the finance world is notoriously volatile. We hoped to examine if some of its volatility could be attributed to these more established markets.
To do this we examined the change in prices of each of the indicators for each day in three years. From this we were able to generate a heat map.
From this we can see that the indicator that shows the most volatility other than Bitcoin was Gold. Then the DJIA and finally the EURO.
Volumes and Correlation
Now that we had some evidence that there was some shared correlation and volatility between the indicators, we decided to quantify these relationships.
While we were doing this we also wanted to explore if the movements in trading volumes were also correlated. Since volume can move independent of price movements, we decided to explore both.
This heatmap gives us some interesting insights. As we can see from the light colored top and right side, gold volume seems to be unrelated to any other indicator. Also we can see that the DJIA price is linked to Bitcoin, but the volume does not have as much of a correlation.
Leading Indicator
Since we have seen the main correlation between the DJIA and Bitcoin is in price, we decided to explore there relationship throughout time. To do this we looked to see if the DJIA could be considered a leading indicator for Bitcoin. A leading indicator means that wherever the DJIA moves, so does Bitcoin.
Conclusions
As the bitcoin markets and other cryptocurrencies mature, we will be able to collect more data on the types of markets they corrlate strongly with.
So far we have seen that in the last three years bitcoin has been heavily correlated with the DJIA. Interestingly enough it is more correlated with this indicator of the US makets than gold or the euro. Indicators of the commodities and currency sectors, respectively.
Not only is it heavily correlated with the price of the DJIA, but its price is also correlated with the volume of the DJIA. These together are strong evidence that Bitcoin is heavily linked to the US Market. Interestingly enough the DJIA is considered to be less speculative than currency markets. Only time will tell if it will fall into a more 'currency like' trading pattern.