Understanding the correlation between different assets in your cryptocurrency portfolio is crucial for navigating the world of crypto trading. Let’s examine Bitcoin (BTC) and Ethereum (ETH) as an example for investors who hold both assets in their portfolio. However, the same approach should be applied across all assets within your portfolio. Since correlation measures how two assets move in relation to each other, it has direct implications for diversification, risk management, and portfolio returns.
In this blog, we will explore the implications of BTC-ETH correlation, why it matters for investors, and how to visualise it using Python.
What is Correlation in Crypto Trading?
Correlation measures how two assets move relative to each other. The correlation coefficient ranges from -1 to 1:
- +1 (Perfect Positive Correlation): Both assets move in the same direction.
- 0 (No Correlation): There is no relationship between their price movements.
- -1 (Perfect Negative Correlation): One asset rises while the other falls.
Why Does BTC-ETH Correlation Matter?
Since BTC and ETH are the two largest cryptocurrencies, understanding their correlation is essential for:
- Diversification: Reducing portfolio risk.
- Risk Management: Avoiding simultaneous crashes.
- Portfolio Returns: Assessing potential volatility.
Implications of BTC-ETH Correlation for Portfolio Holders
1. Impact on Portfolio Diversification
Diversification aims to reduce portfolio risk by holding uncorrelated or negatively correlated assets.
- If BTC and ETH have a high positive correlation (close to +1):
- Both assets move in the same direction.
- A market downturn could cause simultaneous losses.
- There is limited risk reduction.
- If BTC and ETH have a low or negative correlation:
- When one asset falls, the other may rise.
- This helps balance portfolio volatility.
Key Takeaway
- A high BTC-ETH correlation means less diversification.
- Investors should consider adding low-correlated assets such as stocks, commodities, or stablecoins.
2. Risk Exposure During Market Crashes
A strong positive correlation between BTC and ETH means that a crash in Bitcoin is likely to impact Ethereum as well.
Example: 2022 Crypto Market Crash
During the 2022 bear market, BTC and ETH moved almost identically, both losing over 70% from their all-time highs. Investors who held both saw no risk reduction benefits, as both assets crashed together.
Key Takeaway
- If BTC and ETH are highly correlated, investors need other asset classes to hedge risk.
3. Portfolio Volatility & Returns
A high correlation means BTC and ETH experience similar daily, weekly, and monthly returns, leading to:
- Higher potential returns in bull markets, as both BTC and ETH rise together.
- Increased volatility, since both assets experience large price swings simultaneously.
Key Takeaway
- Investors must assess whether they can tolerate the increased volatility from holding highly correlated assets.
4. Rebalancing Strategies Based on Correlation
Since BTC-ETH correlation fluctuates, investors can adjust their allocations based on market conditions:
- When correlation is high:
- Reduce exposure to one asset.
- Add uncorrelated assets such as stablecoins or equities.
- When correlation is low:
- Holding both BTC and ETH may provide some level of diversification.
Example Strategy
An investor notices BTC-ETH correlation rising above 0.9. They could:
- Sell a portion of one asset to reduce risk.
- Add lower-correlated assets such as DeFi tokens, metaverse coins, gold, or stocks.
5. Practical Actions for Investors
✅ Monitor correlation over time – BTC-ETH correlation is not fixed and changes based on market trends.
✅ Consider non-crypto assets – If BTC and ETH are highly correlated, adding stocks, gold, or bonds improves diversification.
✅ Prepare for synchronised crashes – High correlation means both holdings will be affected in a downturn. Keeping cash reserves can help buy assets at lower prices.
✅ Use hedging tools – Futures contracts, options, or inverse ETFs can protect against expected market declines.
Visualising BTC-ETH Correlation Using Python
To better understand how BTC and ETH correlate over time, we can fetch historical data, calculate rolling correlation, and plot it using Python.
Python Code to Visualise Correlation
plt.plot(rolling_corr,label=’BTC-ETH 30-day Rolling Correlation’,colour=’blue’)
plt.axhline(y=0, colour=’black’, linestyle=’–‘, linewidth=1) # Neutral correlation line
plt.axhline(y=1, colour=’red’, linestyle=’–‘, linewidth=1, label=’Perfect Correlation (+1)’)
plt.axhline(y=-1, colour=’green’, linestyle=’–‘, linewidth=1, label=’Perfect Negative Correlation (-1)’)
plt.xlabel(“Date”)
plt.ylabel(“Correlation”)
plt.legend()
plt.grid(True)
What Does This Code Do?
- Fetches BTC and ETH historical price data from Yahoo Finance.
- Calculates daily returns to measure price changes.
- Computes a rolling correlation (30-day window) to smooth fluctuations.
- Plots the correlation over time, showing how BTC and ETH move together.
Takeaway
Holding both Bitcoin and Ethereum in a portfolio makes sense for many investors, but it comes with risks. A high BTC-ETH correlation means:
- Less diversification – both assets move together.
- Higher volatility – simultaneous price swings.
- Increased risk during market crashes – both assets decline together.
To optimise portfolio performance, investors should:
✅ Monitor BTC-ETH correlation over time.
✅ Consider non-crypto assets like stocks or gold for diversification.
✅ Use hedging tools to protect against downturns.
— Caio Marchesani