The dynamic linkage between bitcoin and BGCI cryptocurrencies : a wavelet approach

Abstract

This dissertation is written for the purpose of understanding the individual and paired movements of major cryptocurrencies by analysing their historical data in log-returns, recorded from their launch date of the index to the latest available information (May 2018 to December 2019), through the use of wavelet analysis. Specifically, we conduct the analysis using two wavelet methodologies, known as the Continuous Wavelet Transform (CWT) and the Maximal Overlap Discrete Wavelet Transform (MODWT). We analyse the constituents of the Bloomberg Galaxy Crypto Index (BGCI), which consists of Bitcoin, Bitcoin Cash, EOS, Ethereum, Litecoin and Ripple. Firstly, we find that among the six major cryptocurrencies, Ripple has the most potential to be a true alternative currency to, but definitely not replace, traditional fiat currencies in the future. Secondly, in regard to the prime cryptocurrency of Bitcoin and its impacts, there is significant evidence to suggest that Bitcoin’s returns lead four of the five cryptocurrencies’ returns in the long-run, with the exception of Litecoin where vice versa occurs instead, indicating that Litecoin is possibly becoming more market-efficient due to its 1) independence of Bitcoin, and 2) price reaction ahead of Bitcoin. However, in the short- to medium-run spectrums, we can see that Bitcoin provides different shocks to its counterparts, such that either cryptocurrency in the Bitcoin-pair could lead each other in an in-phase direction (anti-phase co-movements are extremely rare in all spectrums). Thirdly, with respect to portfolio diversification by using the prime cryptocurrency, pairing Bitcoin with Ripple shows the most potential benefits in a two-asset portfolio construction followed by a pairing with Litecoin, as both pairs project mild positive correlations and they are expected to decline in the long-term – suggesting that using merely cryptocurrencies in the portfolio (crypto-portfolio) can reduce portfolio risk. However, with respect to hedging, we find no evidence to suggest that using Bitcoin and these cryptocurrencies provide any offsetting benefits due to their in-phasing co-movements with Bitcoin in general, as negative correlations do not exist at all scales.