The success or downfall of your cryptocurrency portfolio may be hinged on your diversification strategy. Portfolio diversification is an art you need to master before putting your capital at risk.
Why diversify a cryptocurrency portfolio?
Putting all your eggs in one basket could be dangerous and expose you to a high level of risk. Diversifying your portfolio helps you mitigate investment risks and ensure you achieve your financial goals without unnecessarily endangering your funds.
If you have been in the cryptocurrency market for some time, you know that most crypto assets are very volatile. But here is the thing: volatility isn’t really a bad thing. Diversification is a great way to protect your money from unexpected market swings, minimizing exposure to loses that otherwise could break your account.
Whether it’s cryptocurrencies, forex or stocks, putting money on something without a clear strategy behind isn’t investing, it’s gambling. Portfolio diversification refers to the act of investing in different assets or asset classes to lower your risk should one or more of your investments fail to perform well.
Portfolio diversification is not only a hedging method, but it could also boost your returns should the cryptocurrencies you invested in takeoff. The more coins you are invested in, the higher the chances that one of them will offer you outstanding returns.
Since the cryptocurrency market remains a very new field, investors are exposed to even higher risks than those opting for traditional investments. For example, projects still in development might fail to deliver the products or turn out to be total scams.
Sometimes, the projects run into regulatory hurdles and they may be forced to close shop. Think of the Basis project, a non-collateralized stablecoin project that raised more than $130 million from investors but closed down due to regulatory challenges.
Investing in more than one project increases your likelihood of hitting the jackpot while minimizing the damage that may be caused by failed projects.
When to diversify a cryptocurrency portfolio?
When is it the right time to diversify your cryptocurrency portfolio? Anytime. However, diversifying small investments might be more challenging due to the high fees involved.
If you have less than $500 in cryptocurrencies, it may be best to stick to only a few coins, 2 to 3 should be fine, especially if you are a trader. This is mainly due to the potential of diluting your capital by buying several coins. You will lose out a sizable chunk of money in fees. One way to save money on commission is to use services like Crypterium, which integrates the top 10 exchanges to always provide the best rates and lowest commissions on any purchase.
4 types of coins to diversify
Not all cryptocurrencies are the same. While there are many ways to differentiate coins, there are 4 basic groups that you should keep in mind before getting started with a diversification strategy. Understanding each of these groups is vital to diversify your cryptocurrency portfolio efficiently.
Fair enough. Bitcoin isn’t a group, but rather a single currency. Bitcoin is the elephant in the room, the grand-daddy of all cryptocurrencies and all altcoins out there. Its massive volume makes it one of the most volatile assets, but also one of the most profitable. It is just common sense that you keep bitcoin in your portfolio.
2. Ethereum & ERC-20 Tokens
Ethereum was created as an alternative to Bitcoin that supports smart contracts. It took no time for Ethereum to become one of the most popular coins in the market, now the second most valuable cryptocurrency by market cap.
But Ethereum isn’t alone in the game. Many tokens are launched using its ERC-20 protocol, providing Ether with additional strength. Over the years, Ethereum has found competition in projects such as Tron, EOS, WAVES, NEO, and others. But it still remains the most popular.
3. Passive Income Earners
Just like some stocks pay dividends, some coins offer interest to holders. Including a few interest-bearing coins in your portfolio not only serves the purpose of diversification but also earning a passive income.
You can also earn free coins through airdrops and hard forks. Bitcoin Cash, which is itself a fork of Bitcoin, was forked in November 2017 into Bitcoin SV and Bitcoin ABC. All holders of Bitcoin Cash at the time of the fork found themselves with an equal amount of the two forked coins.
4. Stable Cryptocurrencies
Let’s be frank, cryptocurrencies are well known for their volatility. While this is good, there are times when you need to mitigate the risk and that’s where stablecoins come in. The majority of stablecoins are backed by real-world assets or fiat currencies.
Examples of stablecoins include Tether, USD Coin, and Paxos. Facebook has also thrown its name into the hat by introducing Libra, a stablecoin tied to a basket of fiat currencies. Make sure your cryptocurrency wallet supports at least one stablecoin so that you can easily move out of volatile assets in times of market stress.
How to diversify a cryptocurrency portfolio?
The way you diversify your portfolio usually depends on more than just one factor. For instance, you may consider your knowledge and experience in the industry, the economic situation in your country, and whether you love or hate Bitcoin.
The purpose of this article isn’t to present numeric schemes on how you should diversify your digital currencies. Instead, we present you with simple models so that you can identify what works best for you.
This is a good option if you’re just starting in the cryptocurrency world and have little knowledge on the matter. In this situation, diversification sounds a lot like picking out a varied group of coins and allocating an equal portion of capital to each asset.
Risk level: medium-low
Bitcoin maximalists are all in on the leading digital asset and may not even consider investing in other assets. The same goes for Ethereum maximalists. A maximalist investor will invest most funds on a single currency, leaving a small portion for the rest. While this might turn out profitable on some occasions, the associated risks are very high.
Risk level: high
Conservative investors would opt for the biggest and most popular cryptocurrencies on the market and equally divide their funds. In most cases, Bitcoin (BTC), Ethereum (ETH), Litecoin (LTC) and Ripple (XRP) would be among the preferred choices.
Risk level: medium
Whales distribute large portions of their portfolio between two or three cryptocurrencies and then buy small amounts of others.
Risk level: medium-high
Unless you come from countries such as Venezuela, Argentina or Zimbabwe, then you may not fully understand the effects of hyperinflation. Residents of countries suffering from this economic phenomenon tend to use digital assets to hedge against inflation, placing a big portion on stablecoins and leaving a small room for volatile assets such as Bitcoin.
Risk level: low