Crypto Long & Short: What Trends in Volatility Could Mean for Bitcoin

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Please consider using a different web browser for better experience. Please enable JavaScript in your browser for a better site experience. Crypto Long & Short: What Trends in Volatility Could Mean for Bitcoin Jun 29, 2020 at 07:28 UTC Updated Jun 29, 2020 at 07:34 UTC (Chris Liverani, Unsplash) Noelle Acheson Crypto Long & Short: What Trends in Volatility Could Mean for Bitcoin By this stage, pretty much everyone knows that bitcoin’s volatility is well above that of equity markets. This is still true, even after the ructions of March. What is less well-known is that the balance of power when it comes to volatility is shifting. Market data indicates that bitcoin markets are becoming less volatile, and equity markets more so. This seems to be unrelated to the crash in markets earlier this year. You’re reading Crypto Long & Short , a newsletter that looks closely at the forces driving cryptocurrency markets. Authored by CoinDesk’s head of research, Noelle Acheson, it goes out every Sunday and offers a recap of the week – with insights and analysis – from a professional investor’s point of view. You can subscribe here . Of course, it’s possible that this trend turns again. On the other hand, it could point to a broadening interest in bitcoin as an investment asset, as well as a new role for the cryptocurrency in portfolios. Let’s look at the details. It’s all relative First, bitcoin’s volatility is currently below its 2019 average. Not so for the equity markets. Source: Coin Metrics, FactSet (Note: We calculate volatility by annualizing 30-day standard deviations. This smooths variations while still reflecting short-term trends and, as of mid-April, removes the effects of the March crash.) Over the past month, BTC volatility has continued trending down, while S&P volatility has levelled off. Source: Coin Metrics, FactSet This could be a short-term anomaly. Or it could mean that the “standard” expected S&P 500 volatility is now at higher levels than before, while bitcoin’s is lower. The VIX index, which measures expected S&P 500 volatility using options prices, is currently almost three times higher than at the beginning of the year. Source: FactSet Second, this shift is supported by activity in traditional market volatility instruments. Earlier this month, the Wall Street Journal reported on data from Cboe Global Markets data that showed more than a trillion dollars’ worth of derivatives tied to the VIX has traded this year, more than four times the figure a decade ago. It also cited figures from industry tracker Hedge Fund Research that points to a record $19.4 billion of assets in hedge funds that trade volatility. And earlier this week, the iPath Series B S&P 500 VIX Short-Term Futures exchange-traded notes (VXX) – the largest volatility ETN by far – had its second-largest daily inflow ever. It doesn’t matter any more When Fidelity Digital Assets released its survey earlier this month, in which institutional investors were asked about the barriers to investment in crypto assets, volatility was top of the list. With the narrowing of the differential, that barrier could disappear, or at least significantly diminish. It’s not just that bitcoin’s volatility seems to be trending down – if volatility overall is more acceptable, bitcoin’s swings could be seen as less of a negative. Indeed, many of today’s crypto investors see the heightened volatility as an advantage – where else are you going to get high potential returns? What’s more, the strong growth in crypto derivatives gives professional investors more tools with which to hedge the volatility. The breadth of instruments available to crypto investors of all types is steadily widening, and the volume of open interest in bitcoin options heading into Friday’s expiry was more than six times its level at the beginning of the year. Source: In crypto as in traditional markets, options are not just used for hedging – they are also used to trade volatility, a further sign of the growing interest in the strategy. Or does it? Stepping back, it is curious that something that used to be a performance metric is now an investment philosophy. Volatility has moved from the realm of statistics to the realm of strategy. But now there’s an even bigger shift under way. Volatility has traditionally been equated with risk. This makes sense – the greater the swings, the greater the chance you lose a lot. But volatility is not the same as risk – it’s a historical performance metric. True, expected volatility derived from options pricing looks forward, but that measurement is based on data points that don’t claim to actually know what future volatility will be, let alone future risk. Especially in these uncertain times, where bad news lurks around every corner and capital flows can swell across oceans in nanoseconds, we may know what the volatility was yesterday and what is expected tomorrow, but we do not know what the actual risk is. The more we attempt to quantify risk an...