Connectedness of cryptocurrencies and prevailing uncertainties

ABSTRACT

We investigate dynamic connectedness of cryptocurrencies using Generalized Forecast Error Variance Decomposition into short, medium, and long-term phases. Though all phases resemble similar drifts, the magnitude of short-term connectedness is much higher than medium and long-term. Notably, the U-shaped trajectory explains the increasing connectedness of cryptocurrencies with their heightened popularity in recent times. We further utilize Continuous Wavelet Transform to rationalize such connectedness with common economic and financial market uncertainty. Importantly, we show that as economic uncertainty increases, the connectedness among cryptocurrencies decreases. This highlights the potential for cryptocurrencies to be an alternative instrument for hedging against underlying uncertainty.

KEYWORDS:

• Cryptocurrency
• economic uncertainty
• frequency connectedness
• wavelet coherence

JEL CLASSIFICATION:

• C58
• G11
• G17

Disclosure statement

No potential conflict of interest was reported by the authors.

Notes

¹ According to Coindesk (Yahoo Finance), Bitcoin yielded 140.2% (while all digital assets 138.3%) against the returns on US equities of 11.5%, global equities 3.1%, gold 1.8% and global real estate 0.4% in 2017–2018.

² We also tested 3 year data, adding 3 major cryptocurrencies - Ethereum, Tether and Nem, and find similar results. Results are available on request.

³ In this regard, Bouri, Gupta, and Roubaud (2019a) report that herding tends to occur in the crypto market as economic uncertainty increases.