This volatility indicator can help you find your way in the digital asset market

Key Takeaways

• Data shows that the correlation between BTC prices and the VIX is near a year high.
• Global uncertainties pushed the VIX higher, could create additional opportunities for cryptocurrencies.
• Investors should cross-reference the correlation data before making any trade decision.

Overview
August has been a volatile month so far for both financial and cryptocurrency markets. Declines in bond yields and inverted yield curves have been widely discussed in recent days, and the worries over a possible recession in the US resulted in some wide swings in global equities and FX and commodities prices. Of course, BTC and crypto were no exception.

Besides the high correlations between BTC and Gold, the leading cryptocurrency has also shown relationships with the CBOE VIX, and that tie is getting closer.

On the back of the US-China trade war, the Brexit saga, and the rising geopolitical tensions around the world, it’s valid to assume volatility has a greater upside bias in the short/medium-term. How could we leverage those correlations to make a better BTC investment decision?

What is VIX?
The Volatility Index or VIX is created by the Chicago Board Options Exchange (CBOE), it’s a real-time market index that tracks the 30-day implied volatility of a basket of S&P 500 Index options. It’s also known as Wall Street’s “Fear Gauge” or “Fear Index”. 

• A higher VIXsuggests that traders expect the S&P 500 to become more volatile and stressful.
• A lower VIX indicates that options traders expect the S&P 500 to be less volatile and more stable.

The VIX surged pass 24 in early August on the back of the high tensions of the US-China trade dispute and the recession worries, the VIX then slipped back to around 18 later alongside with trade optimism and global stimulus talk.

Figure 1: CBOE VIX Index 

Source: CBOECorrelation between Bitcoin and VIX and Others
Previously, we have studied the correlation between BTC and gold, the distinguishing characteristic of the leading cryptocurrency makes it a safe-haven asset and hedge against market uncertainties, and we believe that the specific nature of BTC was at least partially behind the recent rally of BTC.

Besides gold, we also observed that the VIX has been increasingly correlated with BTC. Figure 2 shows the historical data of the 90-Day rolling correlation between BTC and the VIX, and the correlation coefficient is approaching +0.2. Although the number is not optimal at this point, however, it’s possible that the breakout could develop into a new trend of positive correlation, given the highly uncertain environment. The level of the correlation between the two is near the highest level since January 2017. The correlation coefficient has topped +0.3 in late December 2015, that was the time when the S&P nosedived to 1880 levels, and BTC surged from 300 to nearly 500.

Figure 2: BTC-VIX Return Rolling Correlation (90-Day)

Source: coinmetrics.ioDespite the ties between BTC and the VIX is increasingly closer, BTC’s correlation with gold remained high. Figure 3 compares the correlations between BTC/VIX, BTC/gold, and BTC/DXY (US Dollar Index). The blue and the red lines were mostly in the positive area in 2019, while DXY has shown mostly negative or no correlation with BTC.

Figure 3: BTC-VIX (Red)/BTC-Gold (Blue)/BTC-DXY (Grey) Return Rolling Correlation (90-Day)

Source: coinmetrics.ioInterestingly, the price performances of these assets and indexes speak for themselves. We can see those correlations have been increasing and more noticeable since 2Q19 as the arrows indicated in figure 4. The VIX and gold have mostly positive correlations with BTC, while DXY and BTC somewhat have a negative correlation.

While it’s too early to convince all of the risk-averse investors that BTC is a safe investment, just recently veteran investor Mark Mobius believes the rise of cryptocurrency will reinforce the demand of hard asset such as gold. Mobius who once branded bitcoin a “real fraud”, but he shifted his stance earlier and believe bitcoin and cryptocurrencies will be “alive and well” in the future.

Figure 4: VIX, BTC, Gold and DXY 1-Year Chart

Source: www.tradingview.comTraditionally, DXY and gold have an inverse relationship, and that’s the same case as the VIX and commodities, which also have a negative correlation. Though BTC and crypto as a broad asset class, it is relatively new to the markets, its long-term correlations with traditional assets are yet to be determined. However, in the world of low inflation and stagnant growth, it’s increasingly challenging for traditional money managers to seeking higher investment returns, and many of them turned to cryptocurrency. It’s fair to say that crypto and traditional assets will likely to walk closer rather than further, in fact, investment banks have been putting crypto under their radars.

In late January 2018, Masao Muraki, Global Financial Strategist at Deutsche Bank, highlighted the increasing correlation of cryptocurrencies and the VIX. In a note to his clients, Muraki said: “The correlation relates to a low volatility environment which encouraged investors to move into riskier assets like cryptocurrencies, to achieve decent returns on their investments.”

Examining Your Data
You may notice that the BTC-VIX correlation shown in figure 2 was constantly changing, it had gone below -0.2 up to +0.3 so far, that could mean investors should not always just see things in one perspective or rely on the same correlation to make trade decisions. For example, many of the time that BTC and the VIX were in an inverse correlation back in 2018, and the way how they relate to each other has been shifting regularly. So, the ideal strategy would be using aggregated data, such as the combinations of other correlations and exchange/asset flow data, to achieve positive results.

Conclusion
In the world where interest rates are extremely low, and the uncertainty of sustainable global growth is high, it’s reasonable to expect market volatility will get higher. We have reviewed the correlation between the VIX and BTC and compared the connection with other assets and indexes, the VIX could be another BTC reference that could help investors and traders when it comes to trend discovery of the cryptocurrency, however, the emerging BTC-VIX relationship isn’t a call to rush out and buy BTC, rather it’s one of the signs that indicate cryptocurrency trading and investment is getting more mainstream.

This post also appeared on Medium. Read more.

Disclaimer: This material should not be taken as the basis for making investment decisions, nor be construed as a recommendation to engage in investment transactions. Trading digital assets involves significant risk and can result in the loss of your invested capital. You should ensure that you fully understand the risk involved and take into consideration your level of experience, investment objectives and seek independent financial advice if necessary.