Cryptocurrencies, like most other currencies, are not backed by any solid assets like gold, silver or any other precious commodity. They rely only on the ‘universal’ computational power.
With the multitude of benefits that come with the freedom from asset backing comes a little set-back; crypto volatility.
Fundamentally, the value of a specific digital currency is the value that the investors believe the currency has. Surprising, right?
With the onslaught of crypto comprehension came the flood of new cryptocurrencies in the market. At the time of this writing, there are a little less than 2000 different cryptocurrencies in the market including the ones that are not mineable.
If you are invested in cryptocurrencies, you would have noticed that when a major market holder crypto’s price goes up, some other coins also go up and vice-versa? Turns out, different cryptocurrencies have their own internal relations with other currencies and mostly, they follow a pattern.
How do you measure the movements of crypto prices in relation to other currencies?
The Pearson Correlation Coefficient.
Pearson Correlation Coefficient is a measure of the linear correlation between two variables X and Y. It has a value between +1 and −1, where 1 is a total positive linear correlation, 0 is no linear correlation, and −1 is a total negative linear correlation.
In the cryptocurrency sense, total positive correlation means that the two variables (two cryptocurrencies in our case) are moving in the same direction and will face similar ups and downs in terms of values, while total negative correlation means that that the two currencies are moving in the exact opposite directions. Zero means that these currencies have no correlation.
GeoLinkCrypto, which specializes in cryptocurrency analysis and macro market trends in the crypto sphere, did a great job in calculating the correlation factors for 10 major cryptocurrencies over the years. The results highlight a visible pattern between independent cryptocurrencies.
Notice the red block corresponding to BTC and LTC. It shows a positive correlation between both currencies owing to the fact that they are from the same family and have the same functions. Overall, in 2016, the correlation between cryptos was not quite noticeable.
The slightly darker hue of 2017 shows the slightly increased correlation between these currencies but you haven’t seen it all till you observe 2018.
Almost all cryptocurrencies show a more than 0.5 correlation factor. This means that with time, markets have programmed themselves to follow the herd mentality, following a similar value oscillation pattern.
This may be because either the investors are investing more by analyzing the market trend rather than research basis or that they are thinking of currencies as a group instead of unique individual projects.
The leader of the ring is, of course, bitcoin with 50% market share. making it the one with the whip. Thomas Power, Member Board Of Directors – 9 Spokes, while talking to BlockPublisher went as far as to call BTC equivalent to the ‘Index” because of it’s monopoly on cryptocurrency value graphs.
In conclusion, although cryptocurrencies show a noticeable correlation in trading values, the tables can turn if individual currencies carve out their own names and stop being the underdogs.