One Cryptocurrency to Explain Them All? Understanding the Importance of Bitcoin in Cryptocurrency Returns

Abstract

We utilise principal component analysis to determine whether a (small) set of factors can explain cryptocurrency returns and whether this varies over time. We find that a substantial proportion of cryptocurrency return variation is explained by a single principal component that is highly correlated with bitcoin returns. The explanatory power of this factor is greatest for larger cryptocurrencies and increases markedly in the most recent part of the sample. Our results have implications for investors determining optimal portfolio decisions and for policy‐makers wary of systemic risk.