Asymmetric interdependencies between large capital cryptocurrency and Gold returns during the COVID-19 pandemic crisis
Introduction
In recent years, the growing importance of the cryptocurrency market has led to an exponential increase in the number of papers published in leading academic journals. In addition, the global impact of the COVID-19 crisis is multiplying the number of papers that include a specific analysis focused on this pandemic period. The aim of this paper is to study interdependencies between the largest cryptocurrency and Gold price returns with a focus on the epicentre of the first wave of the COVID-19 pandemic period, from March to June 2020.
The potential interdependence between the most popular cryptocurrencies and Gold has important implications for market participants because connectedness can affect the decision-making of investors (González, Jareño, & Skinner, 2020a and Jareño, González, Tolentino, & Sierra, 2020). If a given cryptocurrency is highly correlated with another financial asset such as Gold, then investors can construct a hedge portfolio consisting of a short position in the cryptocurrency and a long position in Gold to hedge overall risk. Alternatively, if the correlation is low, adding a long position in a cryptocurrency to an established portfolio will lead to further diversification potentially leading to an improvement in the risk to reward ratio. If the correlation is very low and stable, especially during times of market turbulence, then the cryptocurrency can form a safe haven by providing an asset for investors to park their cash until the market turbulence passes. Thus, a deep analysis of the connectedness between cryptocurrency and Gold markets can have a key role for implementing suitable investment strategies that allow investors to manage their portfolios more effectively.
González, Jareño, and Skinner (2020b) find that the contract structure of each cryptocurrency is different so there is no reason to suppose that all cryptocurrencies should behave in the same way, especially during a period of financial stress. Therefore, we conduct a currency-by-currency analysis by running separate regressions for each cryptocurrency against Gold to detect potential divergences among them to discover whether cryptocurrencies behave as a similar asset class like bonds or like stocks or are they a divergent set of assets like commodities.
In addition, an extensive study of interdependence between cryptocurrency and Gold returns during different economic conditions is crucial. Previous studies note that cryptocurrency connectedness with other assets could change over time, so this issue is relevant in a market as volatile as the cryptocurrency market, especially in periods of economic crisis such as the period affected by the COVID-19 pandemic. Consequently, investment strategies using cryptocurrencies as hedging, diversification or even as a safe haven asset could be influenced if the connectiveness of crypto coins change during a crisis period. To this end, this study analyses the behaviour of the main cryptocurrencies (Bitcoin and other large cap alternative coins –altcoins) during the COVID-19 crisis period.
Accordingly, this paper contributes to the previous literature in the following ways. First, our main contribution is to analyse in depth the dynamic rolling connectedness between twelve of the most popular cryptocurrencies and with another financial asset – Gold from January 2015 until June 2020. We discover that not all cryptocurrencies behave in the same way, for example Tether is much less connected to Gold that the other cryptocurrencies suggesting that Tether will perform best in a diversification role rather than as a hedging asset.
Second, this research focuses on the COVID-19 pandemic crisis to determine if the connectiveness of cryptocurrencies change in periods of economic distress. We accomplish this by examining two overlapping subperiods. The first is from January 2020 until June 2020 thereby incorporating the run up to and the heart of the first wave of the COVID-19 crisis period. The second subperiod examines the epicentre of the crisis from March 2020 until June 2020. Consistent with other research into more traditional financial assets (see Junior & Franca, 2012), during the COVID-19 crisis, cryptocurrencies are more correlated and more of them have returns that are cointegrated with Gold returns.
Third, we conduct our analysis using the NARDL regression technique which allows us to examine in a very general way the “connectiveness” of the most popular cryptocurrencies with Gold by examining not only the correlation, but also the cointegration, the long and short run asymmetries and the persistence in the relationship between a given cryptocurrency and Gold. We find that cryptocurrencies develop a long-term as well as a short-term asymmetric response to Gold returns during the COVID-19 period where most cryptocurrency returns respond more to negative than positive changes and exhibit more persistence with Gold returns. Overall, our most important result confirms that the connectedness between Gold and cryptocurrency returns increase during periods of economic turmoil, such as the COVID-19 crisis, suggesting that the hedging role of most cryptocurrencies improve during times of financial crisis just when a hedging asset is most needed.
This paper is related to Jareño et al. (2020) that also examines the connectiveness of Bitcoin with Gold using the NARDL approach. However, this paper extends the investigation from one to twelve major altcoins (unlike most previous studies that analyse exclusively Bitcoin or only 2–3 relevant cryptocurrencies, see Bouri et al. (2018); and Demir et al. (2020) as examples), studying the connectiveness of this expanded list of currencies to another financial asset Gold, and by focusing the analysis on the period of turbulence caused by the SARS-CoV-2 pandemic. We examine the connectiveness of this expanded list of cryptocurrencies with Gold because important variations in connectiveness would suggest that altcoins are alternative assets distinct from Bitcoin. It is notable that this paper discovers that Tether is much less connected to Gold than other cryptocurrencies.
The rest of the study is organized as follows. Section 2 shows a literature review of this fresh topic. Section 3 describes the data and methodology used in this research. Section 4 discusses the most relevant results and, finally, Section 5 collects some concluding remarks and mentions some directions for future research.
Section snippets
Literature review
Two branches of the recent literature have motivated this research. The first branch examines the connectedness between Bitcoin returns and returns of altcoins using different methodologies A second branch of the literature examine potential interdependencies between cryptocurrency returns and the returns of other asset classes. This paper seeks to connect these two branches of the literature by examining connectedness between the twelve largest cap cryptocurrencies and Gold price returns by
Data
The data used in this paper is from the coinmarketcap website and consist of daily log returns of the top twelve cryptocurrencies ranked by market capitalization for a sample period from January 26, 2015 to June 30, 2020. Table 1 reports these twelve cryptocurrencies ordered by market capitalization on June 30, 2020, namely Bitcoin (BTC), Ethereum (ETH), Tether (USDT), Ripple (XRP), Bitcoin_cash (BCH), Bitcoin_sv (BSV), Litecoin (LTC), Binance_coin (BNB), Crypto.com Coin (CRO), EOS, Cardano
Results
This section reports the NARDL model estimates between daily Gold price returns and the top 12 cryptocurrency returns for the whole sample period from January 2015 to June 2020 in the first sub-section, for the epicentre of the first wave of the COVID-19 period from March to June 2020 in the second sub-section and, finally, for the expanded COVID-19 period from January to June 2020 in the third sub-section.2
Concluding remarks and directions for future research
The aim of this paper is to analyse long- and short-run interdependencies between Gold price returns and the returns of the top twelve cryptocurrencies because these relationships could be crucial for market participants when implementing investment strategies. We analyse the asymmetric interdependences by applying the non-linear autoregressive distributed lag NARDL model developed by Shin et al. (2014) over a sample period that runs from January 2015 to June 2020. Additionally, we consider the
Acknowledgements
This work was supported by the Spanish Ministerio de Economía, Industria y Competitividad (ECO2017-89715-P).
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