This article is a brief look at my recent research into bitcoin correlations and how they can be used to increase the profitability of cryptocurrency trading and market making.

Profiting From Bitcoin Correlations

How This Bitcoin Correlations Research Started

As someone who loves numbers, I’ve long had a theory that there had to be a better hedge for Bitcoin(BTC) than US Dollar Tethers (USDT). I don’t have a problem with USDTs but don’t like using a version of pseudo cash when hedging downside moves in Bitcoins.

While cash on the sidelines is a valid position when attempting to minimize risk and reduce losses, I’ve long suspected there had to be a better option.

To find that better option I had to research bitcoin correlations and ask questions others haven’t asked before.

Questions:

I asked myself two simple questions.

Can I offset declines in BTC/USD without going to cash or USDT? Is there a cryptocurrency that is correlated with BTC when it is rising and inversely correlated when it falls?

Answers:

Yes, it is possible to offset declines in BTC/USD without going to cash or USDT.

And yes, there is a cryptocurrency that is correlated with BTC when it is rising and inversely correlated when it falls. (It sounds crazy but all I could do is smile in disbelief when I looked at the data.)

Seeing The Lite(coin)

After going through historical cryptocurrency data[1], I found that Etheruem and Litecoin met the minimum requirements I was looking for as a hedge for cash and USDT.

High Volume High Liquidity Mature Framework and Codebase Strong Mining Network Large and active community

After analyzing the data for BTC, ETH and LTC from August 9, 2015 to December 9, 2017 my findings were more surprising than I expected.

The correlation between BTC and ETH was almost non-existent.

The scatter plot shows almost no correlation between BTC and ETH.

The correlation between BTC and LTC was stronger than I expected.

The BTC to LTC correlation was nearly twice the value of the ETH correlation

The data meant that LTC moved more in correlation with BTC. This helps us to trade and invest more profitably in LTC because the data shows us that it is a more correlated when BTC is rising and falling.

Now to dig into my second question, which is whether there is a cryptocurrency that is inversely correlated when BTC is falling.

Lite(coin) At The End of The Tunnel

Due to the trade from BTC/USD being a paired trade, where the US dollar is base fiat currency, I needed to find a trading pair that would result in me only holding LTC/USD so I wouldn’t have to make two trades just to offset one position.

That solution came in the form of LTC/BTC

(If your exchange doesn’t have LTC/BTC you will most likely have to execute two trades to exchange your USD for LTC. A sell of your BTC/USD which give you US Dollars and then use those US Dollars to buy LTC.)

As you can see below, when BTC/USD is rising, the LTC by comparison an may even be rising as shown by the correlation chart above, but when the BTC/USD falls, the LTC rises to offset your BTC losses when priced in US dollars.

Inverse correlation between BTC/USD and LTC/BTC when BTC/USD is falling.

Conclusion

One can successfully use LTC to offset BTC declines in a falling market and by holding a portion of their portfolio in LTC also profit from LTC gains when the BTC price is rising.

This minimizes and possibly even eliminates the need to go completely to cash or US Dollar Tethers in falling markets. Also, when market making, it provides LTC market making as alternative to market making in falling BTC markets where market making can be detrimental to one P&L statement.

Thanks for reading. If you like this article, follow me out on twitter where I share similar thoughts.

My twitter profile can be found here: https://twitter.com/AoverK

What’s Next

In my next article, I will research volume and price trends across cryptocurrency markets with the goal of determining if there is any link between Bitcoin dumps and Altcoin pumps.

Disclaimer: This article is for informational purposes only. None of the information provide here should be interpreted as a recommendation to buy or sell securities or as specific investment advice. All opinions and ideas expressed here are my own and do not represent any other parties.