My first exposure to cryptocurrency came through Bitcoin. Like many people, I read about Bitcoin’s price movements and quickly decided to buy some. As I researched further I learned about the existence of Altcoins such as ETH and Doge and began to track their prices. It soon became obvious that when Bitcoin’s price moves the price of Altcoins will usually follow. A 2019 academic paper mathematically proved this to be the case. Simply put, Bitcoin is the original and is the king of crypto. The reasons for this correlation are not always immediately apparent. So I found myself asking, ‘Why do Altcoins follow Bitcoin’?
Altcoins follow Bitcoin for many reasons, including the historic availability of crypto trading pairs, Bitcoin acting as a market sentiment indicator and the fact that many crypto traders denominate in BTC terms.
This trend is clearly apparent. However, it is not absolute, nor set in stone. For example, if the Bitcoin price increase 10% you cannot simply assume all other coins will move 10%. Some will outperform and some may even decrease in price. There are thousands of cryptocurrencies and financial markets are complex.
The chart above illustrates Bitcoin/Alts correlation for key Alts. A number above 0.5 is considered a strong positive correlation. You can see that while Bitcoin is clearly correlated with most Alts, the extent differs by currency.
Similarly, correlations do change over time. In fact, the chart suggests that Bitcoin/Alts correlations may be weakening. We will explore these concepts in greater detail in this article.
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Why Does Bitcoin Affect Other Coins?
Having established that Bitcoin does affect other coins, we now need to consider why. Altcoins follow Bitcoin for many reasons, including the following:
- Bitcoin historically was the base currency in crypto trading pairs
- The success of crypto as a whole is tied to the success of Bitcoin
- Bitcoin is considered a market sentiment indicator
- Many traders denominate in BTC terms
- Many cryptocurrencies are essentially Bitcoin clones
Below I explain in more detail each of these points.
Reason #1 – Trading Pairs
Historically, there were not many types of cryptocurrency. Bitcoin was the largest, oldest and most established by a significant margin. Similarly, reliable stablecoins were not widely available until late 2017. For this reason, it made sense that on most centralized exchanges all crypto trading occurred versus Bitcoin. For example, if you wanted to trade ETH, you needed to trade it for Bitcoin.
This created a dynamic by which new investors needed to fund their trading accounts first with Bitcoin (thus increasing Bitcoin price). The Bitcoin was subsequently trading for Alts (thus sequentially increasing Alts price).
Reason #2 – Bitcoin represents the crypto industry
The best-known cryptocurrency, by far, is Bitcoin. Some even consider it synonymous with the industry as a whole. This was true historically and the perception remains valid today. Furthermore, the Bitcoin market cap still represents nearly 50% of the total crypto market cap. For this reason, the success or failure of Bitcoin is seen as being indicative of the probability of the success of other coins.
When the Bitcoin price increases many take this to mean the chance of a specific Alt succeeding also increases. This results in a (slightly lagging) correlation between Bitcoin buying and Alt buying.
Below you see a chart showing the percentage of the total value of the cryptocurrency market that Bitcoin holds. Notice how it stayed above 90% for almost a decade:
This metric can be used to predict “altcoin cycles” and “Bitcoin cycles”. Traders can position themselves more heavily in altcoins or in Bitcoin depending on which way the Bitcoin dominance is predicted to move.
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Reason #3 – Bitcoin as a market sentiment indicator
The fact that Bitcoin affects other coins is not a hidden phenomenon. It is largely accepted as a fact. Most crypto traders are at least somewhat aware of the dynamics we are discussing in this article. For these reasons, it is common and rational to regard BTC price movements as an indicator of the general market sentiment.
For example, if Bitcoin price suddenly jumps, many traders will quickly purchase Alts in the expectation that Alt prices should soon follow. This Alt buying pressure then naturally increases the Alt/USD prices. The BTC/Alt correlation then plays out as a self-fulfilling prophecy. This trend is so established that when Bitcoin/USD price increases it immediately triggers algorithmic buying of Alts by sophisticated trading institutions.
Reason #4 – BTC Denomination
Many active crypto investors and traders have a long-term belief in Bitcoin. They understand the high probability that BTC will outperform the USD over a multi-year or multi-decade timeframe. As such, they may choose to measure their portfolio value in BTC as opposed to USD terms. If they trade altcoins, their default position will therefore be to trade back into BTC, which increases the degree of correlation between alts and BTC.
For example, if ETH increases significantly versus BTC, many traders will sell their ETH holdings for BTC. When applied at a large scale, this dynamic reduces price divergence between Alts and BTC.
Reason #5 – BTC clones
Many Altcoins such as Litecoin and BCH are essentially clones of Bitcoin. They run on a similar proof of work consensus mechanism and rely on similar narratives to drive understanding of their value. It therefore stands to reason that as BTC’s reputation and price increases, these clones also experience increase perception of value. This drives buying pressure and results in these Altcoins largely following BTC’s price action.
Do all Altcoins follow Bitcoin?
Having established the general trend of correlation, you may ask ‘do all Altcoins follow Bitcoin’? The answer is quite simply, no.
Stablecoins is one example of altcoins that do not move in correlation with Bitcoin.
The price of these coins is pegged to specified fiat currencies, like USD or EUR. This is intentional and allows traders to enjoy crypto exposure while reducing volatility exposure. Thus, by design, stablecoin prices remain constant (1:1 with underlying fiat) regardless of whether Bitcoin price is increasing or decreasing.
Some protocols have also introduced coins that specifically move counter to Bitcoin price fluctuations. This is to allow traders to reduce the volatility of their overall portfolio or to reduce risk in uncertain market conditions. This is known as ‘hedging’.
These ‘hedging assets’ can also be used to ‘short’ the market, meaning they gain in value if the rest of the market is decreasing in value. One such token is Synthetix’s Inverse BTC (IBTC). This token is designed to move directly opposite to BTC. For example, should BTC increase 10% in value, IBTC is designed to decrease 10% in value.
In addition, some assets simply have not traditionally followed BTC price action. While their degree of correlation shifts over time, ATOM, LINK and XTZ are well-known coins that have on occasion demonstrated a negative correlation with BTC.
Stablecoin and hedging tokens deliberately do not correlate with BTC. These represent only a very small fraction of the total number of cryptocurrencies in existence. The very large majority of other coins remain slightly or significantly correlated. So if BTC enters a significant price depression, most Alts will as well.
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Will Altcoins Follow Bitcoin Forever?
That Altcoins follow Bitcoin is a long-established trend in crypto. But the question as to whether Altcoins will follow Bitcoin forever remains open.
Firstly, as crypto matures, we are starting to see the industry break into clear sectors. For example, we have Decentralized Finance (DeFi), non-fungible tokens (NFTs), Store of Value (SOV) and other clear sector verticles. More sophisticated investors have moved beyond seeing the crypto industry as an undifferentiated entity.
This means we should expect to see the correlation between sectors start to decrease. For example, in Q3 2021, we have experienced a boom in NFT valuations. This is a result of increasing media attention and celebrity endorsement of the sector. Conversely, during the same time period, DeFi coins have underperformed versus Bitcoin and Ethereum. This is a result of concerns over transaction fees and protocol scalability.
Hence we are already starting to see correlation within crypto starting to decrease. This is also apparent in the chart below. You can clearly see all listed Alts are decreasing their correlation with BTC over the last year.
New sectors can often diverge from Bitcoin significantly. For example, Chainlink (LINK) was the first ‘Oracle’ project to hit widespread adoption. This resulted in a remarkable price run from $0.48 in Jan 2019 to $3.4 in July 2019. While that may not sound excessive by crypto standards, Bitcoin was in a bear market during this period. As Oracles have become established, we subsequently saw an increased price correlation with Bitcoin.
Conclusion – Why Do Alts follow Bitcoin?
Bitcoin leads Altcoins for many reasons. These include historic trading pairs, Bitcoin’s dominant reputation and perception of Bitcoin leading market sentiment.
Some crypto assets such as stablecoins and hedging instruments do not correlate with BTC, however. Similarly, as the market matures we will see less correlation between Alts and Bitcoin.
I personally believe the reduced correlation is both inevitable and healthy for the industry as a whole. Breaking free from Bitcoin dominance will allow investors to assess the merit of a coin on its own value, without having to weigh short and long-term Bitcoin price movements into their analysis. This will allow smaller and less well-known projects to excel and become known in their own right. This is a sign of market maturity and will improve investor confidence.
To draw an analogy, would it be optimal for all shares to trade based on the Tesla stock price? Clearly not, and like the stock market, crypto needs differentiated assets and asset classes.
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