The Risk Protocol Uncovers Key Trends in Volatility Across Crypto Assets

Published: 10 Mar 2023

The Risk Protocol ("TRP"), a specialized investment platform that focuses on addressing some of the risks inherent in investing in cryptocurrencies, has released 'The Nature of the Beast', one of the most exhaustive studies done to date on cryptocurrency returns and volatility. Specifically, the comprehensive research study analyzes crypto volatility and the statistical properties of returns for the 50 largest cryptocurrencies, with the objective of being able to reliably forecast volatility across the sector. Using data and insights from this report, TRP has developed highly sophisticated statistical volatility models that have been empirically proven to provide more accurate forecasts of crypto volatility than either implied or realized volatility.

"A primary motivation for undertaking this research was to be able to reliably price certain very unique and sophisticated risk-managed, decentralized, investment solutions created by The Risk Protocol. However, as we set about devising these solutions that managed directional market risk and volatility, we were struck by how little was understood of crypto volatility. When examined at all, it was through the lens of traditional finance, making the grand assumption that the underlying nature of crypto returns was similar to traditional equity market returns," said Karamvir Gosal, founder of The Risk Protocol and Co-author of the report. "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."

The study shows that 'stylized facts' associated with other financial returns are also exhibited in cryptocurrency returns, however crypto's behavior is distinctly different in certain cases. The full study can be found at and some of its key findings include:

• Unlike equity markets, cryptocurrencies do not consistently exhibit a 'leverage effect,' the phenomenon that an asset's volatility is negatively correlated to its returns. This has potentially significant implications. It means that one cannot necessarily hedge long underlying crypto exposure by being long volatility. If the underlying crypto happens to be one that exhibits an 'anti-leverage effect,' such a strategy would essentially double one's downside exposure instead of hedging it.

• Cryptocurrencies exhibit significant calendar effects. Specifically, there are distinct and persistent 'hour of the day' and 'day of the week' patterns in cryptocurrency volatility. These have implications for crafting effective trading and investment strategies centered around optimal inter and intra-day periods for buying and selling volatility and entering or exiting trading positions.

• While the top 50 cryptocurrencies exhibit material correlation (average 0.524, with Bitcoin and Ethereum having the highest correlation at 0.872), the token LEO (Unus Sed Leo) is uniquely uncorrelated to any other cryptocurrency included in the study (0.013). This issue bears further examination given the controversial past of both Bitfinex and Tether, entities affiliated with LEO.

• The magnitude of cryptocurrency returns or their volatility, is strongly predictable and shows volatility patterns similar to other financial assets. However, they behave more like equities than currencies.

• The annual return correlation between BTC and the U.S. 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 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.

• Unsurprisingly, cryptocurrency returns have a non-normal distribution and are fat tailed with a greater likelihood of extreme events. That said, the standard deviations vary widely across the cryptocurrencies analyzed, ranging from 76% for LEO to 338% for MANA (Decentraland).

• Prior to 2020, there was no significant correlation between BTC, the standard bearer of crypto assets, and the broader equity markets. However, the correlation has become significantly positive since then, especially between BTC and Nasdaq.

• Cryptocurrencies and the broader US stock market exhibit significant volatility spillover, especially in recent years and in some of the more mature cryptocurrencies. TRP's hypothesis is that this spillover is unidirectional, in that volatility in traditional financial markets has an impact on crypto markets volatility, however volatility in crypto is self-contained and does not flow into traditional finance.

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