The Feasibility of Cross-Asset Diversification with Cryptocurrencies

This paper examines the feasibility of effective cross-asset diversification with cryptocurrencies. It uses factor models to control for cryptocurrency market factors and determine the correlation between cryptocurrency and equity markets accurately. This allows to obtain robust results and assess the effect of cryptocurrencies on the volatility and Sharpe Ratio of a portfolio. This paper uses the most comprehensive and up-to-date dataset which covers more than 10,000 cryptoassets for over 10 years. Furthermore, the paper investigates the changes in the effectiveness of such diversification through time. Since March 2020, the correlation between the cryptocurrency and equity market has significantly increased. The beta coefficient of the equity market excess return on the cryptocurrency market excess return became statistically significantly higher than 1 even with controlling for other cryptocurrency market factors. Thus, cross-asset diversification with cryptocurrencies is not effective since March 2020 and was limited before it. The results are additionally supported by researching systematic risk of different quintile portfolios and its changes. After March 2020 systematic risk share in quintile portfolios increased by approximately 20%, which suggests that systematic risk cannot be diversified with cryptoassets nowadays.