Part 1: Analyzing the correlation between BTC and Altcoins

All the gifs used in this series are from the Harry Potter series. Because Magic.

No Bitcoin, you aren’t the chosen one anymore. It’s about time you stopped tanking the market in one of your bipolar mood swings. In this series, we would first try to understand the correlation between Bitcoin and altcoins. Then, we would quantify this correlation in the later parts to understand how we can use this to our advantage. We would look at the top 10 altcoins in terms of Market Capital and calculate their Beta ( a measure of correlation) with respect to Bitcoin.

But first let’s try to understand the market risk inherent in Crypto at the moment and its implications.

You can never eliminate the market risk from your altcoins regardless of how much you diversify or how convinced you are about going all-in on VEN. This is because a majority of the altcoins are tethered against BTC whether you like it or not. At the time of writing this article, Bitcoin amounted to 35% of the entire crypto market capital. Regardless of how much your Delta/Blockfolio wants to convince you by pricing your altcoin in USD, that’s the value in Bitcoin of that alt, translated into fiat.

Let’s try to get a little deeper into this. Since a majority of the trades are made between Bitcoin and Altcoins first, and then in BTC and the fiat of your choice. So if BTC is pumping and you expect a further increase, whales would sell their alt for BTC. And when the BTC correction is coming, they would go back and sell their BTC to buy the same alt cheaper.

Here’s an analogy for you — Say you had a hen (BTC), every time it lays an egg (forks) , you get the egg (new coin) and you get it for free since you own the hen. Now the eggs are well priced in the market which you can trade for free internet moneh. So, now if you wanted more eggs , what would you do ? Right, buy a hen.

This should hopefully change this year as exchanges embedded in other alts get popular and up & rolling ( FairX, EtherDelta, Nex et al.)

Every crypto portfolio would have two types of risk : diversifiable (specific) risk and non-diversifiable (systematic) risk. In equity, diversification across different sectors goes a long way towards risk control. However, the prevalent source of uncertainty in your portfolio is the risk that it is tied into the bitcoin/market(the risk of just being in it). While this risk can never go away, it can, however, be measured so that you can make better decisions.

Adding individual coins into a portfolio for the sake of diversification would be a prudent choice but you should still measure its sensitivity to the market as a whole. This is where BTC comes into play with most of the exchanges offering maximum amount of altcoins coupled with it rather than any other altcoin.

Now that we have done our groundwork on Bitcoin and its correlation with altcoins, we can address the belle of the ball: beta. What is beta ? Beta essentially measures how sensitive a particular security is to the wider underlying spot market. It should be able to tell you: how would your altcoin react if BTC pumped by 20% assuming no changes in the altcoin’s fundamentals.

Now as Dumbledore remarked to Harry in The Half Blood Prince “I told you everything I know. From this point forth, we shall be leaving the firm foundation of fact and journeying together through the murky marshes of memory into thickets of wildest guesswork. From here on in, Harry, I may be as woefully wrong as Humphrey Belcher, who believed the time was ripe for a cheese cauldron.” Well I don’t know about anyone else, but I would be all over a cheese cauldron.

We would assume that the underlying spot market is Bitcoin (which is a fair assumption given most of the altcoin trades are embedded in Bitcoin). So what would this beta tell us ? For e.g. if a coin’s beta value is 1.5, this implies that the altcoin is 50% more volatile than Bitcoin.

By multiplying the beta value of a altcoin with the expected movement of BTC, the expected change in the value of the coin can be determined. Again , going back to our example , if beta is 1.5 and the BTC is expected to move up by 10%, then the altcoin should in theory be expected to move up by 15% (1.5 x 10).

Now the question arises how can we use beta to our advantage ? Well for starters, if the beta of an altcoin is less than 1 then that coin is theoretically less volatile than the Bitcoin and might be a prudent buy in a bearish market which I found to be true for most of the strong core alts (more on it below). Now in a bullish market when every trader is a genius, you can either ride Bitcoin or buy an altcoin with a beta greater than 1 to get amplified returns. Easy enough right ? Although do your research about the fundamentals of your alt.

In the next part, we would look at the beta of the strong altcoins of our choice and see if we can come up with some meaningful inferences.

So far, I have scoured the internet in search of suitable horcruxes. Here’s one of them: UKCrypto, a top notch educational channel created just for Fundamental and Technical Analysis in the Cryptoverse, not for shilling rektcoins to you like McAfee. I am a big fan of their diversification strategy spread across strong core alts.

Well that’s it for this part. Here is a random gif of Dumbledore dancing for no reason whatsoever.