How To Diversify Your Crypto Portfolio and Why It Matters
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Cryptocurrencies are lucrative investment options, no doubt about that. They have outperformed other investment options in the past birthing successful investors in the process. For this reason, many investors have shifted their interest to the crypto space and included leading crypto coins like Bitcoin and Ether in their portfolios.
But as a serious investor, having one or two cryptocurrencies in your portfolio is not enough. Sure the coins will earn you huge rewards when they move in the positive direction, but what happens when they both move the other direction? You end up incurring a huge loss. This is precisely why you need to diversify your portfolio to include other cryptos.
Pull up a chair, and let’s get started on this essential guide to diversifying your crypto portfolio.
What’s crypto portfolio diversification?
Crypto portfolio diversification is the act of ploughing your money into different crypto projects to mitigate risk if one or more projects perform poorly. Executing a diversification strategy also helps you realize the best returns possible even when some of the portfolio items are on a bad run.
Savvy investors know that it is risky to put all their eggs in one basket. The infamous 2018 price crash of several cryptocurrencies, including Bitcoin, best explains why this is not a good idea. If you are a small-scale investor, you might be better off investing in two or three crypto coins. But, if you’re trying to create a sizable portfolio, two to three coins won’t cut it.
Before implementing a diversification strategy, you need to identify the best exchange that suits your needs. The exchange you use shapes your overall experience as a crypto investor and also plays a role in the success of your crypto investment.
How to get started with crypto portfolio diversification?
“Most altcoins are associated with Bitcoin, so how can I diversify?”
This is a frequently asked question and admittedly a genuine concern. While it is somewhat true (the part about most altcoins being linked to BTC), there are still ways to diversify. You just have to look at your crypto portfolio from a different perspective.
Here are some of the best diversification strategy in the crypto space.
1. Type of cryptocurrency
This is a common diversification strategy due to its basic approach. The idea here is to choose different types of well-performing cryptocurrencies and invest in them. Different crypto projects have varying bases and technology powering them. This gives you the option to pick those in line with your investment goal.
Some of the options you have are privacy coins, altcoins, and tokens. When using this strategy, you need to research different aspects such as the price of the cryptocurrencies, their past trends, and future potential.
2. Industry diversification
The approach here is to ensure you have, in your portfolio, crypto coins that fall into different
industries. This way, if one industry takes a hit, the rest of your portfolio can soak in the impact without having a major effect on your returns. You can invest in crypto coins in industries like finance, supply chain, and medicine.
Note that you can also diversify further by using a specific criterion when choosing the cryptos you want to invest in. For instance, you can mix new projects with well-established or alternatively direct your funds into one category.
A word of caution though – don’t plough your funds into a project you have zero to little knowledge about. Take some time to research and understand the industry before making a leap.
3. Time diversification
Although it may sound new, time diversification has actually been around for a while. It is proven and reliable when executed properly. With this strategy, you have to time the market and get your crypto assets at the right moment.
Rather than buying your portfolio all at once, you instead buy parts of it at intervals. You can decide to buy 10% of your portfolio every month. In this case, it will take you ten months to assemble a complete crypto portfolio.
Timing diversification helps you avoid bad timing by taking away the responsibility of poor timing
decisions out of your hands. However, it is grueling as timing the crypto market is difficult, especially if you’re a newbie. It can also be hard to identify the right moment to act.
To get the most out of this strategy, set price alerts on the crypto coins/projects you are interested in. Price alerts cover you by ensuring you stay up to date with trends and shifts in the market. Additionally, they help you prepare for market movements and allow you to react quickly to these changes.
4. Geographical (regional) diversification
Another strategy is choosing to invest in crypto projects from different parts of the world. Depending on your preference and risk tolerance, you can choose to mix between American, European, or even Asian blockchain projects.
Recently, there has been a shift to Asian projects as they are perceived as a good investment. In
addition, they have a loyal following that boosts their chances of being successful.
5. The use cases
Many new investors make the mistake of comparing crypto coins directly. It is not only wrong to
compare them this way, but also misleading. Crypto coins differ in terms of use cases. For instance, Bitcoin was designed to be a virtual currency whereas Ripple was created to facilitate payment transfers in financial institutions like banks. Ethereum, on the other hand, powers DeFi protocols and is key in smart contract technology.
Here is a breakdown of the common cryptos and their use cases.
- Bitcoin – Store of value & payment rail
- Bitcoin Cash, Stellar, Dash – Payment
- Tether, Dai, and PAX – Stablecoins
- Ethereum, Tron, Cardano, and NEO – World computer
Based on this, you can decide to invest in crypto projects with different intended uses. A well-balanced portfolio should cover different use cases unless you have reason to put all your eggs in a single basket.
6. The analytical approach
The analytical approach is a slightly complex diversification strategy and varies depending on the
investor. Here you diversify based on your funds, risk tolerance, and crypto market swings.
You can mix between relatively stable cryptos and the risky ones. Keep in mind that relatively stable crypto projects aren’t safe; rather, they are more stable than other options. Ethereum and bitcoin are the most preferred cryptos for safe stakes. Some of the moderately risky options are Stellar and EOS. Speculative tokens make up the highly risky options.
You can choose to have 60% of your portfolio accounted for by the relatively stable options, with the remaining percentage going to moderately risky crypto projects (say 30%) and 10% to the risky options.
The analytic approach has many other forms e.g. 70/10/1/1/1/1/1/1/1/1/1/1/1/1/1 where you invest 70% in the ‘most relatively stable’ option, followed by 10% on the second most stable crypto project. The remaining 20% is then redistributed across the riskier options. You can opt for a different form like 60/20/5/5/5/5 or 10/10/10/10/10/10/10/10/10/10. The latter is not advisable, though, as it will limit your returns on the relatively stable crypto.
Why diversify your crypto portfolio?
The main reasons why you should consider diversifying your portfolio are:
- It is a volatile world. Diversification is a good shield against the unexpected negative market swings
- and price jumps
- It helps boost the chances of your crypto investment panning out well
- You can’t count on a single cryptocurrency like Bitcoin to give you good returns
- It allows you to make the most out of different coins that are performing well simultaneously
Conclusion
Diversification is a great risk mitigation strategy used by many investors both in crypto and other traditional assets.While it won’t screen you against market-wide correction or a bearish cycle, it will lower your risk when one asset in your portfolio exits the crypto market or has a poor run.
Review your portfolio and determine if it needs diversification. If it does, make the smart decision of executing a diversification strategy that suits you.
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