Bitcoin entering the mainstream could erode its value diversification over time, JPMorgan said

FILE PICTURE: A copy of bitcoin is seen standing on the PC motherboard in this illustration, October 26, 2017. REUTERS / Dado Ruvic / File Photo
FILE PICTURE: A copy of bitcoin is seen standing on a PC motherboard in this illustration

  • JPMorgan said that accepting bitcoin into the mainstream could hurt its diversification value.
  • The bank found that as bitcoin became more mainstream, it was becoming more correlated to other assets.
  • JPMorgan also found that bitcoin has been smaller ssuccessful than other hedges during the stock market pull-down.
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Bitcoin promoters have long touted the role of the cryptocurrency as a diversification tool. A little reason why is because the token is considered disconnected from other assets and so can rally during a large stock market pull-down.

However, a team of JPMorgan strategists said Thursday that as bitcoin and other cryptos become more mainstream, their correlation with other assets increases, and this diminishes their diversification benefits.

“Bitcoin improves long-term portfolio efficiency, but its contribution is likely to decrease as its mainstreaming increases its correlation with recurring assets. And crypto continues to be considered the least reliable hedge during times of acute market stress, “said strategists led by John Normund.

JPMorgan found that allocating up to 2% of a portfolio to crypto can improve portfolio efficiency due to cryptocurrencies’ high air returns, but investors may need to reassess that allocation as cryptos become more mainstream.

“In a portfolio context, mainstreaming cryptocurrencies – especially with retail investors – seems to raise its correlation with all recurring assets (Equity, Credit, Commodities, the EM complex),” JPMorgan said.

Their models show that bitcoin’s cross-asset correlation appears to be increasing, and has coincided with its mainstreaming through products like BTC’s Grayscale fund.

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After examining the largest global stock market drawdowns since 2008 and comparing bitcoin’s performance against other portfolio hedges, the strategists found bitcoin to be one of the least profitable hedges. In the stock market crash of February and March 2020, for example, bitcoin lost 33%, while US treasuries, a more traditional hedge, gained 6%, according to JPMorgan data.

Overall, the strategists found that bitcoin rated the worst in terms of medium earnings (-5%), compared to fiat currency such as the USD vs EM FX (3%). It also does not have a high success rate of turning positive during the stock market downturn. In all the pull-downs studied, bitcoin turned positive 42% of the time, compared to the USD vs EM FX hedge, which has a 100% success rate of offering positive returns during equity withdrawals .

“Market dynamics may differ during a much higher inflation-driven equity market correction in the US and loss of confidence in the dollar is more durable,” the strategists added. “But until and unless those macro concerns happen, the crypto ownership structure tends to underperform in a macro crisis the exact currency it is trying to replace.”

In a more positive outlook for bitcoin, the strategists also said cryptocurrencies could serve as “insurance against dystopia” as high inflation or payment system breakdown.

“Compared to any other asset class or portfolio hedge, cryptocurrencies would uniquely protect portfolios from simultaneously losing faith in a country’s currency and its payment system, because they are manufactured and circulate outside to conventional and regulated channels … “said JPMorgan.

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