Why Should You Diversify Your Crypto Portfolio?
The main reason you should spread out your virtual coins investment is to mitigate risk. Cryptocurrencies are highly volatile; they can go from zero to a hundred within no time and back. Unlike traditional finance, you may not have the luxury of investing in widely differential asset classes that react differently, such as stocks, derivatives futures, and commodities like gold and oil. However, you may still reduce your risk exposure by spreading your assets to virtual currencies in a way that limits the volatility risk exposure of the entire portfolio. This can be achieved by diversifying between high market cap coins such as Bitcoin and newer tokens and stablecoins. That way, you can also earn returns from different crypto streams.
Ultimately, diversification plays a significant role in reducing the risk of permanent loss. Even if one coin crashes, you still have to hold on, and they may even gain value, helping you recover your losses. Traders fully invested in Terra’s UST and LUNA coin lost all their money overnight in 2022. However, if this were only a tiny portion of your portfolio, you would have banked on the distributed amount for recovery. While the crypto market generally appears to move cohesively, the degree of volatility differs from one coin to another.
The other reason you should widely allocate your portfolio is to learn about different crypto projects. There is no better way to be an expert at something than to participate. Most investors are only aware of the already mainstream BTC and ETH, but did you know there are many new projects with different use cases? If you’re a real virtual coin enthusiast, you want to learn about new developments in the industry and how they can help you. Besides, your money will still be growing in value. You may want to try out tokens like TRON (TRX), which promises to decentralize the entertainment industry, or learn other forms of investing, such as coin staking. Eventually, these projects may significantly contribute to your total portfolio profits.
Lastly, diversify your virtual coin investment book for overall better performance. As already mentioned, cryptocurrencies have different volatility levels. In 2021, the total market cap for the industry grew by over 180%. If you only invested in BTC, you closed the year with about 57% gains. However, if you spread your funds among different currencies, you took home huge returns that year. In fact, BTC was probably one of the few coins that didn’t perform exceptionally that year. Solana, for example, raked in 11, 117%. Assuming you had $1000, and equally $250 in BTC, ETH, DOGE, and SOL, you would have cashed in $147 from BTC (59%), $997 from ETH (399%), $8,865 from DOGE (3,546%), and $27,750 from SOL (11, 117%). Your return would be about $37,759, a whopping 3,775% return. Of course, such numbers can only be seen in crypto.
Building a Balanced Portfolio
Now that you know the benefits of having a well-balanced portfolio, here are some strategies to consider in building a diversified crypto investment book.
There are currently over 12,000 cryptocurrencies, each with unique purposes. For example, Bitcoin is meant to be a store of value, Bitcoin Cash and Litecoin are classified as payment coins, USDT and USDC are stablecoins, Compound is a DeFi token, Dash and Monero are privacy coins, and lastly, Decentraland MANA is a non-fungible token (NFT). You want to have all or most of these classes in your portfolio.
Another way to buy crypto is by the various industries they are used in. Industrial uptake of blockchain technology is on a steady rise as the world continues to acknowledge the benefits of these networks. Developers are also building crypto solutions to address real-world problems in various sectors. For example, TRX is meant to decentralize entertainment and bring power back to content creators. Dentacoin and MediBloc target the health sector, VeChain is a supply chain token, while Climate Coin was created to fight negative climate change.
Market capitalization is one of the reliable indicators of the stability of a coin. In most cases, virtual currencies with high market caps suffer less from volatility risks than their counterparts with smaller capitalizations. For example, it takes a considerable amount of investment to move the price of BTC by $1 compared to a coin like HNT, which has a lower cap. That said, you also want to include digital currencies with low market caps in your investment book. Since their prices are easily affected, they tend to rake in the highest returns when the market performs well.
Early crypto projects like BTC couldn’t be associated with any country. However, over time, developers of some projects have headquarters and their assets locked up in certain counties. If you are investing in such cryptocurrencies, you want to ensure you are not putting all your funds in projects tied up in the same geographical region. A simple event like an overnight change in the law could see all your investments vanish.
Bottom Line
To get the most out of your bitcoin investment, you need a portfolio that is well-balanced. But what happens when all the assets in the portfolio crash? A diverse portfolio has a higher probability of surviving than one that is not, even though that is an uncommon occurrence. Nevertheless, certain coins exhibit greater resistance than others, even during the toughest crypto winters. So, diversification should be your initial risk management approach if you plan to take your virtual currency investment program seriously.
FAQ
Diversification is intentionally spreading your investment into different digital coin assets of varying risk and return levels. In this case, if one asset plummets sharply, the value of your investment is protected by the remaining coins. You are also likely to earn higher returns since some assets may rake in more profit than others.
There are many ways you can spread out your digital money investment. According to our experts, the best strategies are diversifying by use case, industry, market cap, and geographical location of assets.
Every coin has two sides. While spreading out your investment dramatically reduces your risk exposure, it also has disadvantages. First, you must constantly conduct intense research to keep up with your entire portfolio, which might be exhausting. Secondly, this strategy might lower your returns due to losses incurred by non-performing members of your portfolio.
Reviewed and Fact Checked by Maryam Jinadu , Fintech and Crypto Writer