Hedging Bitcoin with conventional assets

Abstract

The recent 50% drop in the price of the flagship cryptocurrency Bitcoin reinforces the persistent anxiety among cryptocurrency investors. Can alternative assets hedge Bitcoin risk? This study investigates the ability of equities, commodities, bonds, currencies, and VIX futures to hedge Bitcoin. Our in-sample analysis shows that the USDX, Gilt, Australian dollars, wheat, cocoa, cotton, sugar, copper, and lean hog can hedge Bitcoin, and the out-of-sample analysis reveals that the DAX, Dow-Jones, Nikkei, S&P 500, Brent, and WTI futures can be effective hedging instruments. We use a wavelet-based dynamic hedging model to account for heterogeneous investors in the Bitcoin market. For a short-term horizon, soybean futures reduce the variance in the in-sample hedged portfolio, and cotton futures offer the highest out-of-sample utility. Copper futures are the best for in-sample hedging in a long-term horizon, whereas live cattle futures have the best out-of-sample performance. These results show that conventional assets can hedge wild swings in Bitcoin.