Recall when wealth managers and retail brokerages entered the cryptocurrency space?
The early 2021 bitcoin price peak was caught by well-known Tesla bulls at Gerber Kawasaki. When Wisdom Tree and Ritholtz Wealth Management joined forces to develop a cryptocurrency index toward the end of last year, they may have top-ticked the market as a whole. Then, in April of last year, the US wealth management behemoth Fidelity joined the bandwagon when bitcoin was still trading above $35,000 despite having lost nearly 20% of its value for the year. Since then, it has dropped below $21,000.
Because of the potential benefits of diversification, it is assumed that these institutions decided to allow people to YOLO their retirement funds into cryptocurrencies.
The Swiss Finance Institute’s most recent study, however, pops that bubble. Luciano Somoza and Antoine Didisheim, two academics from the University of Lausanne, examined data from a selection of Swissquote clients, one of the few regulated banks that also provides crypto-trading services. About 21% of the 77,364 active accounts they looked at traded cryptocurrencies.
Their research sheds light on why the S&P 500 and Bitcoin prices have the following correlation:
They contend, in essence, that the high correlation between cryptocurrency and stock prices is a result of retail investors’ co-trading of stocks and cryptocurrencies.
The researchers discovered that the trend began “suddenly” in the first few months of the pandemic in 2020, when the correlation between Bitcoin and the S&P 500 increased sharply from 0% to almost 60%.
While Alphaville can’t help but notice that the increase in retail trading happened at a time when gamblers’ usual arenas were constrained, with casinos closed and the majority of sporting events postponed, Somoza and Didisheim attribute this to retail traders’ stimulus cheques.
Whatever the justification, the survey’s participants in cryptocurrency trading do seem to be the risk-taking kind:
Looking at the stocks that holders of cryptocurrencies prefer, we note a strong preference for speculative and growth stocks. Agents’ overall portfolio becomes riskier when they open a cryptocurrency wallet, with higher annualized returns at the expense of volatility aggregating into a noticeably lower Sharpe Ratio (-10.23 per cent, annualised).
The researchers also discovered that stocks that cryptocurrency traders favor frequently have high correlations with the prices of cryptocurrencies. Therefore, these investors either buy cryptocurrency and speculative stocks simultaneously or simultaneously sell both.
These traders began checking their brokerage accounts much more frequently once they opened cryptocurrency wallets.
It’s also amusing to note that after opening a crypto wallet, these investors traded stocks less frequently, which resulted in an improvement in the performance of their non-crypto portfolios.
Of course, that result makes sense if we assume that 1) frequent trading is bad for an individual investor’s performance and 2) people who enjoy taking on a small amount of financial risk are more likely to open a cryptocurrency account. Investors won’t need to YOLO into selling puts on Gamestop if they can get their volatility fix from cryptocurrency.
On average, cryptocurrency traders trade more stocks than stock traders do after they open a cryptowallet. The dependent variable is scaled by stock holdings, so neither the relative lower weight of stocks in the portfolio nor the amount invested can account for this effect. One interpretation is that after trading cryptocurrencies, investors pay less attention to stocks and do so less frequently. A portion of the higher Sharpe ratios [in their stock portfolios] may be explained by this outcome. Additionally, we discover a correlation between the trading of stocks and cryptocurrencies. In other words, investors trade fewer stocks after they open a wallet and they trade stocks along with cryptocurrencies.
These small-time traders enjoy taking chances. But isn’t it possible that they simply have more money to lose at the casino?
According to the authors’ analysis, “the data suggests that crypto-oriented retail investors are, on average, poorer, younger, more male, more active, and keener on taking risks.”
They continued to be impoverished while having fun.