Financial news

The absence of this leverage effect is one of the central highlights of a new study published by the specialised investment platform The Risk Protocol, which analyses cryptocurrency volatility and the statistical properties of returns for the 50 largest cryptocurrencies.

Lack of leveraging and other findings

Although present in equity markets, the leverage effect fails to appear consistently in cryptocurrency, with potentially significant implications. It means that one cannot necessarily hedge long underlying cryptocurrency exposure by being long volatility.

The study states that if the underlying cryptocurrency happens to be one that exhibits an ‘anti-leverage effect,’ such a strategy would essentially double one’s downside exposure instead of hedging it.

These have implications for crafting effective trading and investment strategies centred around optimal inter and intra-day periods for buying and selling volatility and entering or exiting trading positions.

The study also points to cryptocurrency having volatility patterns similar to those of other financial assets, in that the magnitude of cryptocurrency returns or their volatility is strongly predictable. However, they behave more like equities than currencies.

The annual return correlation between BTC and the US Dollar Index reached a very significant -0.75 level. This lends credence to the popular narrative that over a longer horizon, if the US dollar weakens, one would expect BTC returns to be stronger, with a negative correlation to the dollar.

Cryptocurrencies exhibit gain/loss asymmetry, meaning it usually takes less time to drop a certain amount than it takes to move up by the same amount. Again, this is similar to equities and in contrast to currencies, which exhibit greater symmetry in up/down moves.

Following research initiatives

“A primary motivation for undertaking this research was to be able to reliably price certain very unique and sophisticated risk-managed, decentralised, investment solutions created by The Risk Protocol,” explains Karamvir Gosal, the company’s founder and co-author of the report.

“However, as we set about devising these solutions that managed directional market risk and volatility, we were struck by how little was understood of cryptocurrency volatility,” he continues.

“When examined at all, it was through the lens of traditional finance, making the grand assumption that the underlying nature of cryptocurrency returns was similar to traditional equity market returns.

“Findings from this report have profound implications for participants across the crypto ecosystem, particularly risk managers, asset allocators, investors and traders. It is our hope that this research serves to better inform investors and advisors about this nascent sector and provides a solid foundation for further research initiatives,” concludes Karamvir.