Crypto: confirmed casino

Remember when retail brokerages and wealth managers got into crypto?

Noted Tesla bulls at Gerber Kawasaki caught the early 2021 bitcoin price peak. Wisdom Tree and Ritholtz Wealth Management, when they partnered to create a crypto index late last year, may have top-ticked the entire market. Then US wealth-management giant Fidelity jumped on the bandwagon last April, when bitcoin was down nearly 20 per cent for the year but still trading above $35,000. It has since fallen below $21,000.

Presumably, these institutions decided to let people YOLO their retirement cash into cryptocurrency for the potential diversification benefits.

But a recent study from the Swiss Finance Institute bursts that bubble. A pair of academics — Luciano Somoza and Antoine Didisheim of the University of Lausanne — analysed data from a random sample of customers of Swissquote, one of the few regulated banks that also offers crypto-trading services. Of the 77,364 active accounts they studied, about 21 per cent traded cryptocurrency.

Their findings help explain why the correlation between the S&P 500 and Bitcoin prices looks like this:

In short, they argue that cryptocurrency and stock prices have been highly correlated because risk-hungry retail punters have been trading stocks and cryptocurrencies together.

The academics found that the trend started “suddenly” in the early days of the pandemic in 2020, when the correlation between Bitcoin and the S&P 500 jumped from zero to nearly 60 per cent.

Somoza and Didisheim attribute this to retail traders’ stimulus cheques — though Alphaville can’t help but notice that the jump in retail trading happened right when gamblers’ usual arenas were limited, with casinos closed and most sporting events cancelled.

No matter the reasoning, the crypto traders captured by the survey do appear to be the gambling sort:

. . . looking at the stocks favoured by agents who hold cryptocurrencies, we observe a strong preference for growth stocks and speculative assets. When agents open a cryptocurrency wallet, their overall portfolio becomes riskier, with higher annualised returns which comes at the expense of volatility aggregating into a significantly lower Sharpe Ratio (-10.23 per cent, annualised).

The academics also found that the stocks most favoured by crypto traders tend to be the most correlated with crypto prices. So these investors are either buying both crypto and speculative stocks at once, or selling both at once.

When these traders opened crypto wallets, they started checking their brokerage accounts much more often.

Also entertaining is that these investors traded stocks less often when they opened a crypto wallet, so the performance of their non-crypto portfolios improved.

Of course, if we assume that 1) frequent trading is bad for an individual investor’s performance and 2) people who crave hitting a little financial-risk button are more likely to open a cryptocurrency account, that outcome makes sense. If investors get their volatility fix from crypto, there’s less need to YOLO into selling puts on Gamestop.

Put differently:

Cryptocurrency investors trade more stocks on average but less so after opening a cryptowallet. This effect is not caused by the relative lower weight of stocks in the portfolio nor by the amount invested, as the dependent variable is scaled by stock holdings. A possible interpretation is that investors pay less attention to stocks once they trade cryptocurrencies and thus trade them less often. This result might explain part of the higher Sharpe ratios [in their stock portfolios.] In addition, we find that trading in stocks is correlated with trading in cryptocurrencies. In other words, once they open a wallet, investors trade fewer stocks, and they trade them at the same time as cryptocurrencies.

So these retail traders are into taking risks. But it’s possible they simply have more money to waste on gambling, right?

Well, the data “suggest that crypto-oriented retail investors are, on average poorer, younger, more male, more active, and keener on taking risks,” the authors wrote.

You could say they had fun and stayed poor.