The End of the Crypto-Diversification Myth

Abstract

Cryptocurrencies and equities have exhibited a high and positive correlation since March 2020, making cryptocurrencies a poor diversification tool. We theoretically show that trading flows by retail investors can drive this correlation, even without obvious fundamental drivers. Using a unique dataset of investor-level holdings from a bank offering trading accounts and cryptocurrency wallets, we show that retail investors tend to trade equities and cryptocurrencies in the same direction simultaneously. This behavior became prominent in March 2020. We provide evidence showing that stocks preferred by crypto-investors exhibit a stronger correlation with cryptocurrencies, especially when the cross-asset retail volume is high.

Keywords: cryptocurrency, bitcoin, correlation, households, retail investors

JEL Classification: G12, G14, G51