Diversification helps to reduce losses when some prices fall and benefit from different instruments. We discuss seven strategies to balance the risk in your crypto portfolio.
What is Diversification
Diversification is a broad phenomenon. For example, it can expand the range of products and services produced, and develop new industries for the company to increase production efficiency and gain benefits. In this section, we discuss investment diversification.
Diversification is a fundamental investment principle that helps reduce portfolio risks. When it comes to creating a cryptocurrency portfolio, risk management in this growing, volatile market is important to protect profits.
If you want to become acquainted with the innovations of the cryptocurrency industry, it may not be enough to invest in one cryptocurrency, such as the market leader Bitcoin (BTC). Rather, allocating various digital assets will help profit from growth in the general crypto market.
Using diversification strategies to achieve your investment goals will not only protect your money but also expose you to more crypto assets in the long run.
Seven strategies are used to diversify the crypto portfolios.
Buy cryptocurrencies with various functions.
One way to diversify cryptocurrencies is to invest in cryptocurrencies with different uses or goals. Cryptocurrencies are used as a means of exchange but are not limited to transactions in exchange for goods and services.
Bitcoin, for example, can also be used as a means of saving or preserving and increasing wealth, since it has brought huge profits to investors. Another option is Ethereum, the second-largest crypto in the market, which also has smart contract functionality that allows the creation of digital programs, so this is an investment in the blockchain network, where decentralized applications or dApps can be built.
Crypto investors can also allocate part of their portfolios to stablecoins, which have a value tied to a basic asset, such as a fiat currency. The constant cost of stablecoins, such as Tether (USDT) and USD Coin (USDC), helps moderate cryptocurrency market volatility.
Invest in various cryptocurrency blockchains.
Blockchain technology allows cryptocurrencies to function. However, the capabilities of blockchain platforms go far beyond this, and they are in great demand in almost every sector because of the solutions allowed by technology laws.
The most popular is the Ethereum blockchain, which facilitates the implementation of agreements without a third party and allows dApps to be built on the platform. A competing blockchain is Cardano (ADA), which focuses on security, scalability, and efficiency.
The EOS Blockchain (EOS) specializes in web services such as cloud storage, dApps, and smart contracts. EOS also supports millions of transactions per second and simpler updating and modification of dApps. These are just a few examples of blockchains that underlie the developing cryptocurrency industry.
Diversify by market capitalization
Bitcoin is the cryptocurrency with the largest market capitalization, currently amounting to approximately $810 billion. Bitcoin may occupy the largest part of the cryptocurrency market share, but there are many other altcoins with various market capitalizations that are worth considering.
A cryptocurrency with a larger market capitalization may be more stable and have stronger fundamentals, but a cryptocurrency with a smaller market capitalization may have strong growth potential. For example, Kusama (KSM), with a market capitalization of approximately $1.3 billion, is a promising cryptocurrency that allows developers to experiment with their dApps on their platform before they are deployed on the Polkadot network (DOT).
Diversify crypto projects according to location.
Choosing cryptocurrency projects from different places worldwide can expose you to a wider range of cryptocurrency business innovations. It is best to stay away from crypto projects in areas where cryptography is prohibited or limited and focus on areas where innovation is growing.
For example, Portugal is considered a crypto hub and a tax paradise for crypto investors. El Salvador was the first country to adopt Bitcoin as a legal tender, and the South American nation plans to create Bitcoin City, which is tax-free and funded by cryptocurrencies. In the USA, Texas, Wyoming, New York, and Georgia are trying to attract the crypto industry to their respective states.
Invest in different industries.
Cryptocurrency opportunities are found in various industries. Crypto is the most accepted alternative method of payment in the financial industry. Decentralized finance, or DeFi, allows people to easily conduct digital transactions through a peer-to-peer blockchain network without a third party such as a bank.
DeFi includes not only sending crypto but also lending and borrowing crypto and investing in it. The use of crypto in video games has soared, and an increasing number of users are trading cryptocurrencies in the global virtual market.
Branching into different asset classes.
Digital investment is part of different asset classes, giving investors another way to diversify. The most common asset class, covering Bitcoin and Ethereum (ETH), the native cryptocurrency of the Ethereum network, includes cryptocurrencies that are a repository of value or a means of exchange.
Another asset class is utilitarian tokens that give users the right to use a product on a specific platform. Examples of service tokens include the Basic Attention Token (BAT), Golem Token (GLM), and Filecoin (FIL).
Non-replaceable tokens (NFT) are another class of digital investments. NFT is a digital representation of a property. NFT infiltrated the mainstream through digital art, creating a new outlet for artists to demonstrate their works to the audience.
In addition to art, NFTs can represent the unique digital ownership of many things, such as real estate, collectibles, and even individual identities.
Diversify by risk level.
When building a diversified crypto portfolio, risk tolerance needs to be a priority. Crypto portfolio allocation factor can also be applied to avoid risks.
To balance the crypto portfolio, one can start by highlighting more cryptocurrencies that are more stable, such as Bitcoin and Ethereum, because they have been on the market the longest. Stablecoins can be added to manage portfolio risk.
Then, you can decide to add a smaller percentage of riskier new crypto projects with different uses. Depending on your risk tolerance, you can adjust your distribution to several or many different crypto investments.
Pros and Cons of Diversification
- Reducing the overall level of risk, that is, the likelihood that you will lose a significant amount of money. Diversification reduces the risk associated with cryptocurrencies. If some tokens in the portfolio fall, others can grow and reduce their losses.
- The ability to invest part of the funds in potentially profitable but risky coins, in which you would not invest all funds. In a diversified portfolio, they do not increase the overall risk level.
- Protection against volatility in the market; that is, when asset prices change greatly, they jump either up or down.
- In the long run, a diversified portfolio can improve overall returns.
- Diversification does not protect against systemic risks, that is, those that affect the entire crypt, such as BTC fluctuations.
- The greater the number of assets in the portfolio, the more difficult it is to manage. This takes a long time.
- The more you buy and sell different assets, the higher the fees you pay. Excessive diversification can reduce returns.
- By protecting against risks and losses, diversification limits one’s ability to earn money in the short term.
The cryptocurrency market largely depends on the state of Bitcoin, but the importance of diversifying portfolios should not be neglected. Investments in various cryptocurrencies can compensate for losses associated with Bitcoin recesses; therefore, diversification is very important.
Recall that balancing the portfolio is not just about storing various coins. A well-thought strategy is an important tool for creating the best crypto portfolio for your purposes.