Why Are Bitcoin and Ether More Correlated Than Ever?

Bitcoin and ether may be cryptocurrencies built atop public blockchains, but that’s really where their similarities end.

Yet they trade in almost exactly the same way — their prices move increasingly in tandem to near complete correlation. And they’ve been tightening ever since ether (ETH) started trading almost eight years ago.

Across 2016 and 2017, bitcoin’s 100-day correlation with ether averaged at 35% (where 100% indicates complete correlation, -100% being complete inverse correlation). That number jumped to 66% across 2018 and 77% in 2019, before reaching more than 87% last year.

So far this year, bitcoin (BTC) and ether’s correlation coefficient has averaged out to 98%. So, whatever bitcoin does — ether does too, with near perfect precision.

But why is their correlation increasing, and not decreasing? Their value propositions are quite different.

Bitcoin is a pure-play decentralized cash system that doubles as a store of value. Bitcoin’s famous 21-million supply limit promotes scarcity in the vein of Austrian economics — that commodities should back currencies rather than the state.

Ethereum, on the other hand, supports an array of use-cases outside of the strict money doctrine: digital collectibles, prediction markets, metaverse communities and blockchain gaming.

ETH has no supply limit, with issuance and burn rates more elastic, tied to network usage.

All lines are leading to complete correlation.

Dessislava Aubert, a Kaiko research analyst, told Blockworks that macro investors tend to group bitcoin and ether together as risk assets (or crypto more generally), leading them to treat the two in a similar manner.

“This could explain why they are highly correlated, especially during periods of market turmoil when investors tend to be less discerning,” Aubert said. “However, as these assets mature, and their fundamental differences become clearer this is likely to change.”

Mainstream investors treat bitcoin and ether the same way

A rise in mainstream investment could also be responsible for the correlation. Sam Doctor, chief strategy officer at crypto-focused financial services firm BitOoda, reasoned that the bitcoin and ether camps were initially different, leading to distinct investor groups pumping money into their preferred cryptocurrencies (in other words: BTC and ETH “maximalists”).

More mainstream investors — whether retail or institutional — have joined the market in recent years. “These tend to view crypto more as one trade, want exposure to the asset class and are diversifying into the top two, three or four tokens,” Doctor said.

There are still investors committed to either bitcoin and ether, he added, but as more “protocol-agnostic” investors enter the space, the more correlated these assets should be.

That is, at least until the space matures to where large investors are making very informed decisions about which protocol to invest in,” Doctor said. “Today such investors are in the minority, in my view.”

Specific catalysts, such as Ethereum’s Shanghai fork (which will activate staking withdrawals) could reduce correlations, along with the general maturation of the digital asset class.

But for the most part, bitcoin and ether are still one trade, he explained, drawing similarities between high correlation in airline stocks which can break down when one particular carrier faces a challenge.

Ether began outstripping bitcoin in 2020, but their correlation has since rebounded.

The evolution of bitcoin and ether’s correlation could map to three distinct phases, per Doctor:

Independent crypto projects with their dedicated market adherents (low correlation)
Institutional and retail investors with more passive strategies buying both tokens (high correlation)
More discriminating active strategies (lower correlation)

“At the moment, crypto investors at scale are still somewhat passive investors, rather than actively valuing and shifting between protocols based on an informed analysis of underlying fundamentals,” he said.

There’s another potential factor, beyond investor profiles: how crypto markets themselves have evolved.

Most crypto markets were once denominated in bitcoin

Nick Hotz, vice president of research at digital asset investment firm Arca, explained that in the ‘old days,’ there weren’t any trusted stablecoins (with Tether’s USDT an exception in some cases).

This meant traders on the primary exchanges priced all assets against BTC. And in the early stages of ether’s life, it was considered just another altcoin that was “by and large traded against BTC,” Hotz said. This would have resulted in the assets being less correlated than today.

Hotz cited increased use of stablecoins USDC, USDT and DAI as quote assets as the biggest factor that drove up correlations for other cryptocurrencies relative to BTC across 2018 and 2019.

“A lot of big money now treats BTC and ETH simply as ‘risk,’ since they are the most liquid assets, and not as many trade their pair (ETH/BTC) anymore.”

Correlation streaks are becoming increasingly common.

The correlation of the two today is more representative of external risks, such as monetary policy, crypto adoption, institutional market structure and regulatory risk, Hotz added, rather than the fundamentals of the two cryptocurrencies.

He also cited trends among larger investors, which show them treating digital assets as just one sub-sector of technology. “Assets of the same sector should be highly correlated (see: equity sectors), but should Bitcoin be highly correlated to a token that provides utility in a video game? Probably not.”

Hotz added: “For them to trade independently, there needs to be recognition of BTC and ETH as separate assets with very different fundamentals. Either that or more institutional interest in differentiating the two by pair trading them, which I think is unlikely.”

Studying the correlation between the top two cryptocurrencies and the S&P perhaps reveals the real reason for the former’s tightening correlation: Everything is correlated with US-listed equities these days. Bitcoin and ether are simply no different.

“Periods when you see a spike in correlation [between BTC, ETH and the S&P] are often also periods when the market is risk-off, so correlations have risen across the board,” Doctor said.

Doctor highlighted major events like the 2020 Covid sell-off and the 2022 bear market, marked by increasing BTC and ETH correlation with the S&P: Risk-off markets beget high correlation between stocks and crypto. And markets are mostly risk-off right now.

Risk-off markets bring it all together.

Still, there are signs that crypto markets are starting to make industry-specific investment decisions, rather than pure macro plays.

Kaiko’s Aubert pointed to recently-shrinking correlation between bitcoin and equities markets. The tech-heavy Nasdaq’s 30-day correlation with BTC has declined from an average of 60% last year to between 20% and 30% this year.

“As more value enters Bitcoin and its usage as a store of value increases, it is likely that its correlation with tech equities declines,” Aubert said. “In contrast ETH’s correlation with the Nasdaq could strengthen as it is arguably more similar to tech equities (it’s a decentralized, composable smart-contract network).”

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