The first step in understanding and analyzing the relationships between oil and bitcoin is to recognize that they are not linear but rather multidimensional. Furthermore, we need to understand how they are related as people are aware that bitcoin is profitable, on the other hand, they wanted to know how they can profit from oil trading. The below-mentioned portion will examine whether there exists a correlation between the price movement of bitcoin and oil.
Does a correlation between oil and bitcoin exist?
A correlation can be identified by people between the price movements of oil to that of bitcoin. Therefore, the correlation coefficient analysis was performed by experts to understand the relationship between oil prices and bitcoin prices.
The price data for the two were obtained from Yahoo Finance for one year, i.e. January 1, 2017, through December 31, 2017. Experts did the initial observation by plotting both commodities’ price development. As a result, it was observed that both commodities behave similarly, displaying an almost horizontal trend during most of the year with some changes in the trend towards the fourth quarter.
Both these commodities have shown similar trends concerning their prices during 2017. The relationship between oil and bitcoin prices is highly correlated as both share almost the same direction of movement. This observation was further confirmed and verified by the regression analysis. The graph plotted by experts depicts a high correlation coefficient of 0.998 between oil and bitcoin prices for 2017.
It confirms that bitcoin and oil have been behaving similarly concerning their prices throughout 2017. In this relation, it can be deduced that if there exists a correction in oil prices, then there will be a correction in bitcoin prices, too, because they are calibrated to each other while exhibiting similar trends, i.e. positively correlated price movements.
Bitcoin mining affects the price of oil:
Bitcoin mining is a mechanism where transactions are recorded in the blockchain, an immutable ledger for all transactions in the system. These are solely done to prevent any fraud committed by any user on the platform. If someone tries to commit fraud, they will be penalized, and their account will be frozen.
The size of blocks mined by miners can also affect oil prices because it has been found that larger block sizes make it more difficult to mine bitcoins as it consumes more computational resources. s It results in fewer bitcoins being mined, leading to a lower supply of bitcoin, which translates into higher demand for bitcoin, increasing its price and hence making oil prices increase well.
Current status of this correlation:
Experts can explain the correlation by considering the supply and demand theory. An increase in oil prices generally leads to a decrease in demand for these commodities as consumers look to substitute away from oil, adversely affecting oil prices. On the other hand, the high price of bitcoin acts as a substitute for gold, which many investors consider a safer asset than shares or bonds. Bitcoin price increases are not limited only to gold but are similar to stocks, bonds, and real estate because of their increasing popularity among investors.
It can be concluded by people from the regression analysis of bitcoin prices against natural gas spot prices. Users can infer that a change in the price of bitcoin will also have an equally good effect on oil prices. But, it is because the bitcoin price does not move by itself, requiring substantial energy, computational power, and bandwidth to be processed by miners.
Suppose you examine these resources required for Bitcoin. In that case, users will observe that they are found to have a considerable positive correlation with oil prices because these commodities require a considerable amount of energy, computing power, and bandwidth for processing transactions on such an unalterable distributed ledger network.
However, to make it more accurate, the companies should use a secondary source of data related to natural gas prices rather than oil prices, as given in the regression equation. Therefore, users can complement it by using oil price data from a secondary source, such as an oil producer or an exchange like Bloomberg or Reuters.
Bitcoin prices are highly correlated with Oil prices because both these commodities require a considerable amount of energy for processing transactions on their respective networks meaning that if there is an increase in oil prices, then there will be a decline in bitcoin prices and vice-versa.