We’re going to analyze 2 years of historical data from Coinmarketcap (CMC) from June 22, 2016 to June 20, 2018. CMC derives price by taking the volume weighted average of all prices across every exchange.
1. How many coins are strongly correlated with the market? Let’s run through an example of how to calculate correlation between BTC and the market. Once we have data for BTC’s market cap and the overall market, we can calculate the Pearson correlation coefficient between the two over the entire time period. Here’s the correlation matrix between BTC & the overall market.
If the correlation coefficient is 0, this suggests there is no observable linear relationship between the two. A correlation coefficient of +1 implies that the pair will always move in the same direction.
All we have to do is repeat this process for each of the top 200 coins. Then we can plot a histogram and density plot with all of the correlation coefficients.
Our density plot indicates that most coins in the top 200 are highly correlated with the market. 75% of the top 200 coins have a correlation of 0.67 or higher. 50% of the top 200 coins have a correlation of 0.80 or higher. When the market goes up, most coins are also likely to go up. And when the market goes down, they are bound to follow.
2. How many coins are strongly correlated with Bitcoin? Although its market dominance is not what it used to be, many people are under the impression that most cryptocurrencies follow BTC’s price movements. Let’s explore if that’s true. To calculate correlation between each of the top 200 cryptocurrencies and Bitcoin, we’re going to take the same approach we used earlier. After running this calculation for each of the top 200 coins by market cap, we can create our density plot:
The belief that most coins are correlated with BTC is true. Most of the top 200 coins by market cap are correlated with BTC. 75% of the coins in the top 200 have a correlation of 0.44 or higher. 50% of the coins in the top 200 have a correlation of 0.67 or higher. However, it does seem that the correlations between the top 200 coins and BTC are weaker than the correlations between the top 200 coins and the overall market.
3. What are the coins that are in the top 200 by market cap that are the least correlated to Bitcoin?
4. Are there any coins that are resistant to large market movements? There are very few coins that are negatively correlated with the overall market.
5. How are the coins in the top 20 by market cap correlated to each other? Harry Markowitz, the father of modern portfolio theory, postulated that the most important aspect of risk to consider is an asset’s contribution to the overall risk of the portfolio, rather than the risk of the asset in isolation. This means that by including assets with low or negative correlation in your portfolio, you can reduce the overall variance and therefore reduce the risk of your portfolio.
Across the top 20, we do see instances where certain coins have low correlations with each other e.g. BTC & Vechain, Dash & Vechain, Ethereum-Classic & NEM. Having combinations of coins with low correlation is why diversification can significantly reduce risk.
The article was published for the first time at https://www.bitcoininsider.org/article/30897/how-many-cryptocurrencies-are-simply-following-marketTweet