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A diversified portfolio is a crucial measure to mitigate risks, and also a safe way for newcomers to enter the crypto space.
You must have heard the phrase “Don’t put all your eggs in one basket”. In the context of investing it is straightly referred to what diversification means. With focusing on diversification as a top priority, you can build a robust and balanced crypto portfolio to achieve successful investing.
Diversify or Not?
Diversifying your investments across various assets is key to successful cryptocurrency and any other type of investing, reducing risk and volatility in your portfolio. In turn, a more stable portfolio can potentially lead you to higher returns in the long run.
Matt Hougan, Chief Investment Officer of Bitwise Asset Management, noted:
“Proper diversification is key to success in the digital asset space, where the performance of a single asset can often dictate the outcome of an entire portfolio.”
Although diversification can reduce overall risk and volatility in a portfolio, it’s important to note that a concentrated portfolio can generate both higher losses and higher gains due to volatility. If you have a higher risk tolerance and conduct proper research on each asset, you may not need to over-diversify your portfolio.
However, many investors prefer a well-balanced crypto portfolio that can minimize risks and increase mid- and long-term profits. To reach the best possible results, it is important to build a diversified and balanced crypto portfolio. Here are some strategies that can help you achieve this goal.
Invest in Low-Correlated Assets
When it comes to diversifying your cryptocurrency portfolio, understanding the correlation between different currencies is crucial. Asset correlation is a measure of different assets interlinkages, and how they move relative to each other. Investing in highly correlated cryptocurrencies can lead to concentration risk, where a downturn in one cryptocurrency can have a ripple effect on the entire portfolio.
When diversifying your portfolio, it’s important to choose cryptocurrencies that have low or negative correlations with each other. For example, while Bitcoin (BTC) and Ethereum (ETH) tend to move in the same direction, other cryptocurrencies like Cardano (ADA), Polkadot (DOT), and Solana (SOL) have lower correlation with BTC and ETH. Diversifying across lower-correlated coins can potentially reduce your overall portfolio risk.
Tyrone Ross Jr., Financial Advisor and CEO of Onramp Invest, said:
“Correlation is an important factor to consider when building a cryptocurrency portfolio. If you own a basket of assets that all move in the same direction, your portfolio is not truly diversified, and you are still vulnerable to concentration risk.”
Therefore, diversification with a mix of high and low-correlated cryptocurrencies is necessary to spread your risk and capture market gains in different market conditions.
In addition to the correlation among cryptocurrencies, there is also a correlation between cryptocurrencies and stocks. It is influenced by factors such as supply and demand, investor sentiment and expectations, economic conditions, monetary policy, geopolitics, and government regulation. Investors and traders treat cryptocurrencies similarly to traditional stocks, leading to comparable price trends between these assets. For example, the day after the Federal Reserve’s announcement on increasing its target federal funds range to 0.75%–1% on May 4, 2022, Bitcoin fell to around $31,000. So, selecting a diverse range of cryptocurrencies based on asset correlation is vital for improving overall risk-adjusted returns when diversifying a portfolio.
Mind the Legal and Country Risks
Regulations on cryptocurrencies vary by country, with some banning or restricting their use while others create favorable environments. To protect your portfolio in uncertain conditions, diversify assets across regions and research the performance of global crypto projects while complying with relevant regulations.
For example, China’s crackdown on Bitcoin mining and trading significantly reduced the hash power on its blockchain, which affected the cryptocurrency’s price. Consequently, many Chinese Bitcoin miners relocated to more crypto-friendly nations like Kazakhstan. In the United States, Texas, Wyoming, New York, and Georgia are trying to attract the crypto industry to their states. El Salvador has adopted Bitcoin as legal tender and plans to establish a tax-free “Bitcoin City” funded by cryptocurrency, potentially increasing global adoption, and price. Portugal is also becoming a crypto hub and tax haven for crypto investors.
When building a diversified crypto portfolio, focus on regions that encourage crypto innovations, taking into account country-specific risks and regulations.
Allocate Assets in Different Cryptocurrency Blockchains
Cryptocurrencies operate on various blockchains, which have different solution directions, capabilities, and reliability levels.
The Ethereum blockchain is the most popular, as it enables the execution of agreements without the need for a third party and supports the development of dApps on its platform. Cardano (ADA) places a strong emphasis on security, scalability, and efficiency. The EOS (EOS) blockchain, on the other hand, specializes in web services like cloud storage, dApps, and smart contracts, and can support millions of transactions per second. Additionally, it offers simpler upgrades and modifications to dApps.
In technical terms, blockchains can be categorized as public, private, or consortium-administered, with each having varying levels of susceptibility to hacking or manipulation. For instance, the Ethereum-based Poly Network experienced an exploit in 2021 due to a vulnerability, resulting in the loss of over $600 million in various cryptocurrencies.
You can potentially reduce your exposure to risks associated with a single blockchain by diversifying across various blockchains, including but not limited to Bitcoin’s blockchain, Binance Smart Chain, and Solana’s blockchain. Choosing different blockchains with consistent growth could be a wise decision.
Invest in Different Market Cap Assets
The total value of a cryptocurrency circulating supply is known as market capitalization, which serves as a trustworthy indicator of a cryptocurrency’s security. Generally, a higher market cap is considered to indicate a safer cryptocurrency.
While top-10 market capitalization coins like Bitcoin (BTC) or Ethereum (ETH) are considered to be more stable and may have more solid fundamentals, a cryptocurrency with a small market cap could experience rapid growth. Mid-cap cryptos – any top 10 to 50 coins by market cap – often have caps between $1 billion and $10 billion like Solana (SOL), Avalanche (AVAX), or Dai (DAI). Kusama (KSM) is an example of such a cryptocurrency, with a market cap of around $1.3 billion, that enables developers to test their dApps on its platform before deploying them on the Polkadot (DOT) network.
Given the crypto market’s expansion, mid-cap cryptocurrencies can be highly profitable investments, especially if you perform research to determine whether they can develop in response to market demands. Diversifying across various market cap assets, you can potentially balance your portfolio by combining the stability of larger coins with the potential for higher returns from smaller coins.
Buy Different Types of Crypto with Various Use Cases
While cryptocurrencies are primarily used as a means of exchange, they are not confined to transactions for goods and services only.
For instance, Bitcoin is not only a medium of exchange but can also serve as a store of value, with the potential for significant returns. Ethereum, the second-largest cryptocurrency network, offers smart-contract functionality, enabling the creation of digital programs and decentralized applications (dApps). Allocating some of the portfolios to stablecoins, such as Tether (USDT) and USD Coin (USDC), can help manage volatility, as they are pegged to an underlying asset like fiat currency.
In addition to holding cryptocurrencies, you can diversify your portfolios using various crypto instruments such as futures and options, or exchange-traded funds (ETFs) that track multiple cryptocurrencies. Conduct thorough research before investing in any of these instruments, as each one comes with its unique set of risks and benefits.
For example, Bitwise 10 Crypto Index Fund (BITW), a crypto ETF that offers exposure to a diversified basket of cryptocurrencies. BITW invests in cryptocurrencies like Bitcoin, Ethereum, Cardano, and Polkadot, among others. Alternatively, as an investor, you could also utilize crypto derivatives such as futures and options to hedge your positions or potentially profit from price movements.
Given that some cryptocurrencies may have little practical use, and others are specifically designed to provide innovative solutions and improve existing systems, diversifying across different use cases can mitigate risks. Keeping track of market trends and staying informed on the latest developments can help you make informed investment decisions and stay ahead.
Diversify by Industries
The development of cryptocurrencies covers a wide range of applications, from payment systems to games to social networks. Expanding your investment portfolio to include different industries or sectors can help diversify your assets and broaden your understanding of different segments of the cryptocurrency market.
The adoption of blockchain technology, which is the backbone of cryptocurrency, has been rapid across multiple industries such as banking, healthcare, insurance, retail, and telecommunications, recognizing the advantages of leveraging blockchain technology. The gaming industry has also observed a notable increase in the usage of cryptocurrencies with an increasing number of people now participating in the trading of digital assets on a global virtual marketplace.
To illustrate, you may diversify your crypto portfolio by holding Basic Attention Token (BAT) to gain exposure to the digital advertising sector, and Theta Fuel (TFUEL) to access the video streaming industry. These cryptocurrencies are unique in their use cases and may have lower correlations with other cryptocurrencies, such as Bitcoin and Ethereum, which are primarily used for their store of value.
There are industries we’re more about and interested in somehow. You can start more detailed research with them, exploring then new industries – established or emerging. This can help you select the most suitable cryptocurrency to invest in and potentially provide you with valuable diversification benefits for your portfolio.
Use Crypto Trackers to Rebalance Portfolio Regularly
Rebalancing is crucial for maintaining a diversified cryptocurrency portfolio because of adjusting the asset weightings to balance risks. It involves buying or selling cryptocurrencies to achieve the desired risk level. The main advantage of rebalancing is to return to a chosen level of risk and maximize profits, whether done daily, weekly, or yearly.
Regularly rebalancing a diversified cryptocurrency portfolio is important to adjust asset weightings, maintain the chosen level of risk, and maximize profits. After establishing the desired portfolio proportions, it is a good thing to periodically verify that the portfolio still adheres to the specified allocation. Fluctuation of asset values still happens over time, so occasional checks are necessary – daily, weekly, or yearly.
Using a crypto tracker with a clear dashboard is a useful tool for monitoring and regularly rebalancing your portfolio. There are many free crypto trackers available that can help you keep your portfolio in check, such as the NOW Tracker by ChangeNOW team. Regularly rebalancing your portfolio with a crypto tracker can help you achieve better long-term results while simplifying the diversification process.
A diversified portfolio is a crucial measure to mitigate risks, and also a safe way for newcomers to enter the crypto space. Successful Investing can be achieved by considering factors such as a correlation between currencies, geographical diversification, different blockchains, market capitalization, crypto instruments, and diversification across various sectors. Remember to conduct thorough research, invest only what you can afford to lose, and keep in mind that the crypto market is unpredictable and subject to sudden price fluctuations.