The failed promise of crypto diversification

One day, crypto assets may replace gold as a traditional safe haven for investors, but we’re not there yet. So far, the value of crypto appears to depend on many of the same drivers as equities, says TD Economics.

In a new report, TD noted that so far, the crypto market has failed to provide investors with any shelter from the downside in traditional assets and macroeconomic risks.

“Equity markets went through a substantial correction over the first half of 2022 and cryptocurrencies went along for the ride,” it said.

While crypto assets had lower correlations with equity markets when economic growth was strong and interest rates were low, as the economic environment has deteriorated, crypto proved highly correlated with the stock market.

“The experience of the past year suggests that cryptocurrencies, like equities, are a growth-linked asset and investing in them is an investment in future economic growth, albeit more volatile than investments in other growth-linked assets,” the report said.

As for their potential as a form of “digital gold” that provides a safe haven for investors, the report noted that, in 2022, there has been near-zero correlation between returns on gold and the major crypto assets.

Moreover, while there are endless different crypto assets, there’s little evidence that they provide diversification within the crypto space itself — as the value of most assets appears to be highly correlated to the dominant players, Bitcoin and Ethereum, the report noted.

“In other words, an investor in this market would have difficulty diversifying their risk,” it said.

While the report acknowledged that the crypto space is still in its infancy, and that the market may well evolve, at this point, crypto assets have failed to fulfill their promise of improving on traditional financial assets.

“It is possible that future innovations in this area will lead to a crypto-asset which can function as a safe store of value and hedge against economic risk for its investors, but that world is difficult to see today,” the report said. “Right now, they look like an asset class that depends on the same factors as other risk assets.”

James Langton

James is a senior reporter for Advisor.ca and its sister publication, Investment Executive. He has been reporting on regulation, securities law, industry news and more since 1994.