A seasoned investor knows better than to put all eggs in one basket, but what’s the best way to diversify crypto holdings? Picking the right assets is only part of the solution, as portfolios also need to be readjusted. Discover time-tested advice in our guide!
#1 Diversification essentials
In the crypto space, there is a lot of hype. Some of it is justified, some of it is pure manipulation. Not all cryptos solve real-world problems and have a future, so always do your own research. Consider market capitalization and potential to pick a base for your portfolio.
Experts recommend allocating a portion of funds into stablecoins — tokens pegged to fiat currencies or commodities. Apart from having a fixed value, they may be lent out to earn interest. Thus, a portion of your holdings will always be gaining, even when the market goes south.
Another key to mitigating risk is choosing unrelated assets, but many cryptocurrencies are correlated. Even small high-growth projects are affected by broader market trends. Yet if you spread your risk and invest modest amounts, the successful ones will boost your portfolio.
#2 Rebalancing act
Rebalancing is a set of strategies for preserving an ideal proportion between the digital assets you hold. This includes taking profits, stopping losses, selling high, and buying low. When any of the tokens deviates from a predetermined value, you restore the allocation through trades, manually or automatically.
Proponents of rebalancing think long-term and tend to overlook fleeting market hikes. When one of their assets soars, they redistribute the gains to other holdings, restoring the original weightings. This way, they keep the risk level in check.
💡 Suppose you hold five different cryptos: ETH, LTC, DOT, ADA, and XRP. How would you spread your risk across them? Some holders prefer an even spread — 20% for each coin. In this case, 20% is the target allocation to maintain.
Since all cryptos have different fiat values, you must assess their weight in the same base currency. Therefore, if the whole portfolio is worth $200,000, each of the five components must be worth $40,000.
Top rebalancing strategies
There are many ways to readjust asset allocations in this capricious market. In the absence of universal recipes for stress-free trading, rebalancing, particularly automated, mitigates the risk and psychological pressure.
Threshold portfolio rebalancing
This approach is based on setting a strict tolerance band, such as 10%, to limit the movements of each crypto. You buy or sell an asset when it rises or falls beyond the threshold. Here are a few basic examples.
- With a dual portfolio divided in half between token A and token B, you could choose 40/60 as the maximum allowed split and readjust once this threshold is crossed.
- A possible scenario for three tokens is 50% to X, 25% to Y, and 25% to Z with the maximum allowed deviation of 10%. Once token X grows to constitute 60% of the portfolio value, you sell some of it to buy Y and Z and restore the initial split.
Constant proportion portfolio insurance (CPPI)
This strategy requires adding stablecoins to the portfolio to temper the volatility. For example, one may hold $40,000 worth of fiat tokens and an equal amount of crypto. If the market turns against them and the coins shed 20% of value, they will only lose $8,000 — half of what could have been lost otherwise.
Calendar crypto rebalancing
Prioritizing time instead of value or proportions simplifies the task. This approach prescribes rebalancing every hour, day, week, or month. Shorter intervals entail higher transaction costs but lower portfolio deviations. The more rarely you rebalance, the less you pay for it, but the bigger the drift.
According to Shrimpy’s estimates, hourly rebalancing is less efficient than daily and weekly adjustments when the trading fee is 0.25%. With lower fees, however, this strategy forges ahead.
#3 Dollar-cost averaging (DCA)
The idea of the strategy is to invest fixed dollar amounts at regular intervals regardless of where the prices go. Those who do not have a lump sum at hand can make small payments from their regular cash flow.
DCA requires that the fiat value of your investment remains fixed at all times, which soothes some of the anxiety caused by market swings. If one token goes up, you can buy more of it. In a bearish market, you will be able to do the same, buying even more of that crypto.
#4 Portfolio tracking tools
Managing a diversified portfolio across exchanges is not a manual task. Fortunately, dedicated trackers can analyse and aggregate data from multiple wallets in a single dashboard. Users do not have to log into each account every time.
Taxation also comes into play. If you live in a jurisdiction where selling crypto is a taxable event, such as the US, you need software for record-keeping and analysis. All of these advantages and convenience, however, have a price, but free trials are also available.
As the tracker will connect to your crypto exchange accounts, pay close attention to its safety and security features. In terms of layout, look for clarity and intuitiveness — you shouldn’t spend a lot of time figuring out how to use the interface.
#5 Profit and loss calculation
One of the ways to control your investments is by analyzing profit and loss (PnL). You can do it in different ways — on a transaction-to-transaction basis or by calculating year-to-date results.
There are several factors to consider, including the buy and sell price, trading volume, and exchange fees. This data can be used to determine the percentage and amount of profit or loss from each and all trades in the portfolio.
Transaction-to-transaction
Performing a profit and loss calculation for each transaction includes two steps:
- Calculating the cost price and value of the trade in local currency, including trading fees
- Comparing the two figures to determine whether a profit or loss was made
If only one trading pair is used, the cost price of the transaction is equal to the initial value of the assets, including trading fees. The trade value is the value of your assets at the time of the sale. Profit is the difference between the two, including trading commissions.
In case of several trading pairs, the cost value of first transaction (A) is not equal to that of the second transaction (B), which is the trade value of A. It is necessary to add up the profits from all transactions and subtract all fees involved.
Example
On January 1, you buy 1 BTC for $28,000.
- Trade value = $28,000.
On February 1, you sell 1 BTC for 15 ETH when ether is at $2,000.
- Trade value = $30,000 (15 ETH x $2,000).
- Unrealized profit = $2,000 (trade value $30,000 — cost value $28,000).
On March 1, you sell 15 ETH for 17 PAXG when the stablecoin (pegged to gold) is at $1,900.
- The new cost value is $30,000 (the value of 15 ETH).
- Trade value = $32,300 (17 PAXG x $1,900).
- Unrealized Profit = $2,300 ($32,300 — $30,000).
- Total unrealized profit for Q1 = $4,300 ($2,000 + $2,300).
Remember to take into account all trading fees applied. Your profit will be realized when you sell the holdings (in this case, PAXG) for fiat. While it is still unrealized, it is subject to market volatility, unless you convert it into stablecoins.
Year-to-Date (YTD)
HODLers can compare the value of their balances at the start of the calendar year with that at the present date. Ignoring the exchange rates at the time of each transaction, you look at the rates at the end of the period.
Example
At the start of the calendar year, you hold 1 BTC bought for $28,000. At the end of the period, you have 17 PAXG worth $34,000 (17 * $2,000).
The total value of your portfolio at the present date is also $34,000. The unrealized profit is the difference between the final and initial portfolio value: $34,000 — $28,000 = $6,000.
#6 Exit strategy
Like all humans, crypto investors have psychological biases preventing rational decisions when the going gets rough. A winning streak is exhilarating as dopamine — the chemical released in our brain — makes us feel good about our decision-making.
What happens when the market is a sea of red? Without an ready plan to fall back on, you may hold on to some tokens for too long and sell others too early. Every trend ends sooner or later. Oversaturation causes reversal.
Decide at what prices you will close your trades for a profit, and do the same for losses. Stick to this plan whatever happens. Check out our article to avoid common mental traps.
Bottom line
💡 Managing a crypto portfolio is not an easy task and takes time and effort, which is why dedicated software is in high demand. Diversification, rebalancing, and thorough analysis of profit and loss will help you achieve better results and hedge risks.
