DeFi versus TradFi assets: dissecting diversification effectiveness in varying economic policy uncertainty regimes

Abstract

This study examines the diversification and hedging potential of cryptocurrencies and traditional financial assets during periods of varying economic policy uncertainty (EPU). In the identified periods, we analyze return and risk characteristics of six well-known cryptocurrencies (i.e. Bitcoin, Ethereum, Solana, Cardano, Ripple, Binance coin) alongside with traditional assets (S&P 500, gold and T-bills) and assess their effectiveness in investment portfolios. The methodology is separated into two sections. First, we objectively identify periods of economic distress by employing the Bai-Perron structural breaks test on the EPU time series. Then, in each subperiod, we employ a set of return and risk metrics using multiple rolling window specifications, as well as measure the correlation coefficients in order to estimate how useful the selected cryptocurrencies as well as TradFi assets (Gold, T-bills and S&P500 index) are in investment portfolios. Gold maintains superior safe-haven characteristics compared to all cryptocurrencies during high EPU periods, exhibiting lower volatility, reduced correlation with equity markets and more stable positive returns. Among cryptocurrencies, Bitcoin demonstrates the strongest safe-haven properties during periods of elevated economic policy uncertainty, maintaining lower correlation with traditional financial markets compared to other digital assets. The decentralized nature of cryptocurrencies provides limited hedging benefits during policy-driven uncertainty episodes, as their risk-return profiles remain inferior to gold's established safe-haven characteristics. Cryptocurrency performance exhibits significant heterogeneity across different EPU regimes, with certain digital assets showing strong performance in specific episodes but lacking consistency over time. We have two elements of originality. First, we objectively identify periods of low versus high economic uncertainty via the Bai-Perron structural breaks test. This eliminates subjectivity in the period selection, which is a problem in other research. Second, we identify a high-EPU period characterized first by the trade policy measures taken by President Trump but also by a pro-crypto regulatory agenda. We analyze the behavior of cryptocurrencies in this period and compare their performance with Gold and the S&P 500 index.