Return Imbalance Under High Correlation: Why is Funds Being "Squeezed Out" of Altcoins?

Over the past year, the cryptocurrency market has shown a stark contrast to the US stock market. The S&P 500 and Nasdaq 100 indices have seen cumulative gains of 47% and 49% respectively over the past two years, while the altcoin index has been mired in a downturn. The crypto market is undergoing a structural shift, with capital concentrating on high-quality assets.

The S&P 500 is projected to rise 25% and 17.5% in 2024 and 2025, respectively, while the Nasdaq 100 is expected to rise 25.9% and 18.1% during the same period, with a maximum drawdown of only around 15%.

In contrast, the altcoin market saw the CoinDesk 80 Index (which tracks 80 crypto assets outside the top 20) plummet by 46.4% in the first quarter of 2025, and as of mid-July, it had fallen by 38% year-to-date.

The MarketVector Digital Asset 100 Small Cap Index is projected to fall to its lowest point since November 2020 by the end of 2025, with the total market capitalization of crypto assets evaporating by over $1 trillion.

The core of this contrast is the "imbalance in returns under high correlation". The CoinDesk 5 index (tracking major cryptocurrencies such as Bitcoin) has a correlation of 0.9 with the CoinDesk 80 index. They move in tandem but their returns are vastly different. The former rose by 12%-13% during the same period, while the latter fell by nearly 40%.

The risk-adjusted return gap is even more pronounced. The volatility of the Altcoin index is comparable to or even higher than that of US stocks, yet it recorded a significant negative return with a negative Sharpe ratio; while the Sharpe ratio of US stock indices has remained consistently positive.

Over the past five years, the MarketVector Small Cap Crypto Index has returned -8%, while the Large Cap Crypto Index has risen by 380% during the same period, clearly indicating that institutional funds have voted with their feet.

Kaiko data shows that although altcoin trading volume has rebounded to 2021 levels, 64% is concentrated in the top 10 altcoins, while "institutional-grade" assets with regulatory clarity, such as Solana and XRP, have become a few winners.

Funds have not withdrawn from the crypto market, but rather flowed upwards along the quality curve, with Bitcoin and Ethereum spot ETFs continuing to attract institutional investment.

For investors, diversifying their portfolios with altcoins is no longer meaningful. The near 0.9 correlation between CoinDesk 5 and CoinDesk 80 means that holding altcoins does not yield diversification benefits but instead incurs additional risks.

The Altcoin Season index's sharp drop from 88 to 16 at the end of 2024 further confirms its tactical trading nature rather than its long-term asset allocation.

The current market logic has completely changed: capital no longer favors niche altcoins, but instead focuses on high-quality targets with clear regulations and sufficient liquidity.

Bitcoin and Ethereum have gained institutional recognition through ETFs, while US stocks attract funds with their stable returns. Together, these factors have squeezed out the survival space of inferior altcoins.