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Author: Admin | 2025-04-28
There are influential, common risk drivers across crypto assets using a statistical technique called Principal Components Analysis.Using Financial Risk Factors to Explain Risk in CryptoMany established risk models, like our own Two Sigma Factor Lens, are constructed to explain the majority of risks and returns in traditional financial portfolios, which often include heavy allocations to well-established asset classes like stocks, bonds, commodities, and fiat currencies, as well as to well-known investment strategies such as trend following in macro asset classes and value investing in stocks.To our knowledge, most financial risk models do not incorporate idiosyncratic crypto risk as a “factor.” If crypto has mostly unique risks and returns that are specific to the crypto market, then any portfolio with allocations to crypto will have residual, or unexplained risk, according to these factor risk models. In order to understand the extent to which crypto is correlated with factors in traditional financial markets, let’s start by analyzing Bitcoin’s relationships with the factors in the Two Sigma Factor Lens.10 Bitcoin is the largest crypto asset by market cap and is arguably the most canonical. For a brief overview of some of the ways that investors can transact in crypto and obtain other types of crypto exposures, please see Appendix 1 in the pdf version of this article.The exhibit below shows how the Two Sigma Factor Lens, which does not include a crypto factor, attempts to explain Bitcoin. 91% of Bitcoin’s risk since January 2015 was unexplained. This is a relatively high amount of residual risk. For context, broad-based equity indices like the S&P 500 exhibited The 9% of Bitcoin’s risk that was explained by the model can be attributed primarily to three significant factor exposures: positive Equity, positive Trend Following, and negative Emerging Markets. There were other statistically insignificant factor exposures that are
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