The old adage about not putting all the eggs in one basket has been used as a metaphor for diversifying investments for as long as anyone can recall but does it play out in the cryptocurrency market?
One Basket Maybe Better
A Reddit user recently posted about an experiment they undertook putting 10,000NZD into the top 50 cryptocurrencies and showed a chart of how it was going after a month. In a long streak of red, there are four columns of green. That is four coins out the top fifty that came out on the plus side.
This simple experiment shows that cryptocurrencies tend to move in a correlated manner and therefore diversification makes little sense.
In the traditional fiat markets, diversification is used to smooth out fluctuations in an investors portfolio by hedging assets against one another to increase the chance of making gains. Knowing how assets correlate with each other should provide a map to effective diversification. Investors use correlation coefficients to measure how one asset will offset another.
A simple example of a correlation coefficient is to compare asset ABC with XYZ. If in this scenario ABC gains 10% and XYZ loses 10% the two are perfectly negatively correlated which in a world of examples makes them a perfect pair for diversification.
In the cryptocurrency market though where Bitcoin remains the bellwether that leads the prices of all other coins through lows and highs does any of this traditional trading wisdom apply? According to the Reddit experiment, it doesn’t.
Diversification Doesn’t hold up in Crypto
The poster diversified their investment into 50 different assets for a month and only four of them gained while 46 loss. There is no balance in that diversification. The 8% winners in his portfolio are an anomaly while the 92% losers were correlated to the downward trend in the market led by Bitcoin.
During the bull rush of 2017 when Bitcoin gained roughly 200% all other major coins also enjoyed sharp increases in value. According to CoinMarketCap Ether rose more than 5,000%, XRP 4,000%, Litecoin 4,000% etc. Since the turn of the year when the market turned bearish and Bitcoin has lost more than half it’s value with moderate fluctuations in price all the aforementioned coins have also suffered.
What the Reddit posters sheet shows is that cryptocurrencies are closely correlated with the price of Bitcoin. Exceptions do occur due to the highly volatile and emotional nature of the cryptocurrency space but winners in a losing market are most likely flukes and not a hedge for diversification. Perhaps the best strategy for crypto investors is to put all your eggs in one basket and HODL or select a few cryptocurrencies and hold long-term, rather than selecting 40 to 50 cryptocurrencies.