What is Heart’s Law?
Heart’s Law describes that the prices of assets that trade against each other tend to move with each other because the liquidity bonds them in their trading pair.
Example: You can exchange Bitcoin for Ethereum in their liquidity pair; if Bitcoin goes up in price, Ethereum moves up in price. Price correlates because you can exchange it for the asset that went up in price whenever you want.
Richard Heart invented Hearts law and stated that the price of things that trade against each other tend to move up together. Major cryptocurrencies like Ethereum hold many strong bonds with their trading pairs; that’s why as Ethereum goes up in price, it tends to pull the entire market with it.
How does Heart’s Law work?
It is usually challenging to comprehend the market’s movement, involving hundreds of thousands of individual players. Yet, many assets tend to move in the same direction for an unknown reason. Heart’s Law explains that no invisible force moves other assets when something goes down. We can see that happening using numbers in the following example.
Let’s pretend 100 BTC at $40,000 each in a liquidity pool that holds 10,000 units of Coin A at $400 each. Assume this pair is the only liquidity pool for Coin A.
Remember: Liquidity pools require the exact value of assets on both sides to provide liquidity.
(Token A quantity) * (Token A price) = (Token B quantity) * (Token B price)
With this example, no trades have been executed against this pairing between BTC and Coin A, but on the market, BTC has gone up 10% to $44,000 through other trading pairs.
As the value on both sides of a liquidity pool must remain the same, what will happen to the data in the Pool Info to maintain the same price with BTC’s price increase?
(100 BTC) * ($44,000) = (10,000 Coin A) * (X)
(100 * $44,000)/(10,000) = X
X = $440
The new value of Coin A is now $440 (a 10% increase) as it must maintain constant weight in the liquidity pool. Further, Coin A has no other trading pairs. Having only one trading pair reflects a 1.00 correlation in price movement between the two assets.
Why don’t all coins have the same price changes?
As BTC and ETH are some of the most frequent trading pairs in the crypto space, we see strong price correlations throughout the ecosystem due to the coin’s bonds in their liquidity. The bond results in the whole market following BTC and ETH’s prices in either direction. Furthermore, many coins have bonded liquidity trading pairs with other currencies, such as stablecoins. It offers a hedge against a pure correlation resulting in different velocities of price in those exact directions.
Heart’s Law identifies the similar crypto market moves due to their trading pairs bonded by liquidity. Richard Heart was the first to recognize this phenomenon and explain it in simple terms for all to understand.
You should evaluate your portfolio; first, check how much of your assets are paired with coins such as BTC and ETH to assess whether or not there is risk in riding the bear market down when those assets are dropping. Diversifying your portfolio with cryptos that move freely in the market due to bonded pairs with stablecoins can help hedge your investments against the bear market.
Source: Richard Heart