Weakening Correlation Between Bitcoin and Ether Returns
The correlation between Bitcoin and Ether returns has weakened following Ethereum's Shanghai upgrade, potentially impacting institutional investment strategies and supporting diversification arguments.
Introduction
The correlation between Bitcoin (BTC) and ether (ETH) returns has been on a downward trend since mid-March, according to a recent research report by Coinbase. The decline has become more pronounced following the successful completion of the Ethereum blockchain's Shanghai upgrade, also known as Shapella. This change in correlation dynamics may affect institutional investment strategies that rely on cross hedging, and also supports diversification arguments in favor of holding both BTC and ETH.
Background
Traditionally, the correlation between BTC and ETH returns has been relatively strong, owing to the interconnected nature of the cryptocurrency markets. However, since mid-March, when BTC started outperforming against the backdrop of U.S. banking turmoil and increased regulatory scrutiny of non-bitcoin digital assets, this correlation has been weakening.
Ethereum's Shanghai Upgrade
The decline in the relationship between BTC and ETH returns became more pronounced following Ethereum's Shanghai upgrade, which was successfully completed on April 12. The upgrade enables validators to withdraw staked ether, and a similar trend was observed in September 2022, following the network's previous update, the Merge.
Coinbase analysts David Duong and Brian Cubellis noted that the weakening of the 40-day correlation of daily returns may continue for another two weeks, as the initial phase of ether withdrawals following the upgrade is still in effect. Coinbase estimates that as of April 20, an additional 73,000 ether could be unlocked in partial withdrawals and 822,000 unlocked in full withdrawals, a process that could take approximately 15 days to complete.
Implications for Institutional Investors
The falling correlation between BTC and ETH returns has important implications for institutional investors. For quantitative strategies that rely on cross hedging one asset for the other or using ETH as a hedge for less liquid altcoins, the changing correlation dynamics may necessitate adjustments in investment strategies.
From a fundamental perspective, the weakening correlation supports diversification arguments in favor of holding both BTC and ETH. This trend may encourage institutional investors to consider allocating capital to both cryptocurrencies, as they exhibit increasingly distinct return profiles and risk characteristics.
