By Nathan Ferguson
When it comes to investing, the ultimate goal for each investor is to maximize profit while reducing risks. As a result, they develop investing objectives and apply various investment approaches to profit from current market trends. Investors who use these tactics typically spread their wealth to various assets rather than a single one. Even though prices may fall, diversification is essential to ensuring that your profit margins stay relatively intact. It is because a portfolio comprises a variety of different types of investments.
So that they produce superior long-term yields while reducing the risk associated with any single investment. It is the core notion upon which the concept of portfolio diversification is founded.
Although some argue that cryptocurrency is not an asset class, cryptocurrency has gained tremendous traction in recent years and is now being viewed as an asset category worth investing in. However, “diversification is a way to invest that can be applied to any financial market, including the cryptocurrency industry”, according to a blockchain expert named Malviya.
With cryptocurrency becoming more widespread, more individuals are rushing to the financial markets to get their feet wet in the world of cryptocurrencies trading and investing. Although many investors assume that merely adding Bitcoin to their investment is sufficient, this is not always the case,” he continued.
In his explanation, Malviya stated that investors tend to concentrate all of their cash on a single-asset rather than establishing a sound portfolio diversification technique out of the approximately over 11000 digital assets currently accessible. ‘This method is problematic in and of itself, especially if the goal is to generate a profit,’ says the author.
Investing in a single investment can, of course, provide you with 100 percent of the unrealized losses related to that asset; nevertheless, it’s important to understand that not all virtual currencies’ gains or losses are created equal. Furthermore, while Bitcoin’s price has increased significantly in recent years, many other cryptocurrencies have outpaced Bitcoin in value gain, including Ethereum and Litecoin.
That’s why it is critical to begin exploring beyond Bitcoin and to diversify your assets across several different cryptocurrencies. Apart from the notion that you may reduce risk while earning big gains, he added other advantages to investing.
Portfolio Diversification
As an investment strategy, diversification can be applied to any financial market. The significance of allocating funds throughout different asset classes to balance risk versus returns is well understood by seasoned investors. Many people, however, are unaware that this approach is also pertinent when allocating funds among different asset classes.
A good place to start is distributing your capital across a wide variety of financial markets such as stocks, bonds, commodities, and cryptocurrency. However, this strategy is effective when you further diversify each asset class. For example, a stock investment portfolio should include stocks from various sectors of the stock market, such as energy stocks, technology stocks, healthcare stocks, and so on. It holds true for your cryptocurrency portfolio as well.
What Is Cryptocurrency Portfolio Diversification?
Diversifying your cryptocurrency portfolio refers to investing your funds in several cryptocurrency projects to reduce the risk of losing your money if any projects perform poorly. It also helps to attain the best possible returns even though some assets perform poorly, which is another advantage of implementing a diversification strategy.
Investors who are well-versed with the crypto industry always advise not to put all of their eggs in one basket. It may be more advantageous to invest in 2 or 3 cryptocurrencies if you are only a small-scale investor. Nonetheless, if you want to establish a substantial portfolio, two or three cryptocurrencies will not be enough to get you started.
Why Is Diversification Of Cryptocurrency Portfolios Important?
In contrast to the vast majority of conventional assets, the digital assets market is extremely volatile. Investors might benefit or lose money when prices unexpectedly move in various ways numerous times a day, depending on their position in the market. As a result, while volatility can improve profitability, it also increases the likelihood of experiencing losses by a factor of 10.
According to some analysts, it is not uncommon for the value of BTC to plummet by 50% within a few days. In such cases, investors who have a significant amount of money invested in the Bitcoin blockchain would experience a sharp decline in the value of their investment portfolio.
It is recommended that one spreads one’s funds among a variety of digital assets to avoid such a degree of risk exposure. Using this investment technique, you can limit the amount of money you lose while the market is in a slump. Assuming that you have only invested a portion of your funds in Bitcoin and have dispersed the remainder across a range of other cryptocurrencies, it is doubtful that a 50% Bitcoin meltdown will be as catastrophic as it could otherwise be. It is due to the fact that the success of the component crypto-assets in a broadly diversified would more than compensate for the losses.
For example, although Bitcoin may be having a 50 percent decline, Ethereum, on the flip side, may only be seeing a 25 percent decline. The addition of stablecoins to the portfolio decreases the danger even further. And fortunately, DeFi tokens may be experiencing a price increase. Individual investments may suffer losses in the short term, but the collective performance of crypto assets in a broadly diversified portfolio may be sufficient to compensate for these losses over time.
Notably, the risks associated with a Bitcoin-centric strategy are equally prevalent in an investment focused on Ethereum or Bitcoin or any other virtual asset. The idea here is to ensure that you do not have a significant amount of money invested in a single cryptocurrency, whether it is Bitcoin, Binance Coin, Ethereum, or any other 5,700 digital assets available.
Reasons Why You Should Diversify The Crypto Portfolio
Total Control Over Your AssetsAs you may be aware, one of the most important characteristics of cryptocurrencies is their decentralization, making them potentially immune to government interference and manipulation. Because authorities and governments are powerless to interfere, they cannot influence or control the situation. It provides clients with the ability to handle their money in whatever way they choose, without being restricted by the restrictions of a typical financial institution.
- Transaction Fees Are Low
Unlike conventional payment methods, which are subject to significant transaction costs when transacted internationally, cryptocurrency transactions are simple to conduct both locally and internationally. Because there are no intermediary businesses or governments involved in the transaction, the costs of using a cryptocurrency such as Bitcoin are generally less expensive than those of using a bank transfer.
Furthermore, because there are no authorization procedures and no extensive waiting periods, your transaction will be completed much more quickly. Aside from that, there are no additional fees, like deposit or withdrawal fees, reserve ratio fees, or any other expenses.
- Infinite Options
The ability to choose from a diverse selection of investment opportunities is critical when investing in any business. The number of investment opportunities you have increased in direct proportion to your options. At the moment, there are more than 11000 cryptocurrencies in circulation around the world, giving you a choice to invest in any of them. Every day, the cryptocurrency market expands, and every time someone develops a new token, it is introduced to the market’s inventory.
It is unnecessary to be overwhelmed by the availability of over 11000 cryptocurrencies; you can narrow your search to the top 50-100 cryptos by filtering your list. Typically, the ten leading cryptocurrencies are preferred by most investors, but there are more others to consider. Sites such as Coinmarketcap categorize cryptocurrencies according to their market capitalization and provide more information on each currency, making the decision-making process easier for you.
- New Investors Find It Very Appealing
Because of the potential for huge profits, bitcoin tends to attract investors of all income levels, from extremely affluent individuals such as Elon Musk to everyday people. The emergence of concepts such as NFTs, DeFi, and crypto derivatives and the popularity of these concepts have sparked demand and engagement in the cryptocurrency market, signaling that cryptocurrency investments aren’t going away anytime soon. Therefore, there is clearly a great deal of area for investment expansion in the cryptocurrency space as a result of this.
- Stable Store Of Value
One of the most common reasons for investing in cryptocurrencies is the desire for a secure, long-term store of value. Unlike traditional money, the number of cryptocurrencies is limited. As a result, any government entity cannot reduce its value due to inflation. Because of its cryptographic nature, governments cannot tax or seize coins without the owner’s consent. This property appeals to many people, particularly those concerned about banking crises, hyperinflation, and other natural disasters.
How Can You Diversify Your Cryptocurrency Investments?
When diversifying your investment portfolio, the most crucial thing to watch is the correlation between price movements. To the greatest extent practicable, try to hold virtual currencies that do not tend to trail themselves. The efficacy of this technique is reduced if you have an excessive amount of these products in your portfolio.
You might be beginning to wonder: How can you recognize digital assets that do not correlate with one another? There are a variety of approaches that can be used in this situation.
- Diversify By Type:
It is a frequent diversification method because of the fundamental approach it takes. This strategy aims to make several different sorts of high-performing cryptocurrencies. Different crypto projects are powered by a variety of different technologies and have a variety of different foundations. It provides you with the choice of selecting those that are consistent with your investment objective.
You can select from various privacy coins, cryptocurrencies, and tokens. To be successful with this method, you must conduct an extensive study into many elements such as bitcoin pricing, historical trends, and prospects.
Some of the several types of cryptocurrencies that exist today are as follows:
Payment Coins: Bitcoin Cash and Litecoin
Smart Contract Cryptocurrencies: Ethereum and Binance Coin
Store Of Value Assets: Bitcoin
Stablecoin: Dai and USDC
Non-Fungible Tokens: Decentraland and Chilli
DeFi Tokens: Aave and Compound
Privacy Coins: Monero and Dash
Please keep in mind that the cryptocurrencies described here are only examples of the types of coins and are not financial recommendations to buy. The idea is to create a well-balanced portfolio of cryptocurrencies that includes all of the different classes of cryptocurrencies so that you are always well-positioned to benefit from an increase in demand for any of them.
- Diversify By Industry
Investment in a wide collection of coins that may be utilized to solve problems in a variety of businesses is a good idea. It will help you limit the negative impacts on your investment caused by crypto-unfriendly regulations and events, which will help you protect your investment.
Ensure to undertake complete research and then invest in both secure and rapidly rising organizations. It would help if you also analyzed the general profitability of the company and fields that are competitive worldwide, such as medical and finance.
Keep in mind not to put your money into a product you know nothing or only a little about. Before taking the plunge, do some research and learn as much as you can about your chosen sector.
- Diversify By Geography
Another method is to make investments in bitcoin projects that are being developed worldwide. According to your interests and risk tolerance, you can switch up blockchain initiatives from the U. S., Europe, and Asia.
Maintain diversification by ensuring that all of your funds do not go to digital currency projects that are in the same location or country – conduct extensive research on the success of digital currency projects that are in different regions of the world. Even in difficult market situations, this will help shield your assets from regulatory uncertainty while also providing you with another means of balancing your broad portfolio.
- Diversify By Timing
The concept of time diversification, while this may appear to be a fresh one, has been there for quite some time. It has a proven track record and is extremely dependable when implemented right. It is necessary to beat the market and buy your digital currencies at the appropriate time in order to succeed with this technique.
When investing, it is impossible to eliminate market risk; but by being cautious about where and when you invest, you can increase the value of your portfolio. Diversifying your portfolio via timing is essentially an interval-based investment approach when it comes to investing. To invest in your selected tokens, you need to set aside particular sums of money at specific periods throughout the year.
Investing in new cryptocurrencies at a low price while the market is down is a fantastic idea; conversely, when the market is up and the price is high, you’re in a perfect position to offer and profit.
Advantages Of Crypto Diversification
As a rule, diversification has two advantages: it offers your investment with “non-correlated” assets, which means that when some investments tank, others remain stable or even gain in value, and it (hopefully) shields you from devastating events when one of your assets implodes.
When it comes to cryptocurrency, the first advantage is only marginally relevant. According to the Financial Times, bonds tend to grow in price when stocks fall in value, which allows investors to ride through bad markets with a traditional investment portfolio. On the other hand, Cryptocurrencies tend to increase and fall in tandem.
The true advantage of diversifying cryptocurrency is that it helps to reduce the likelihood of severe results. According to experts, if one coin fails and your investment goes directly to zero, other cryptocurrency investments may still do well. In an ideal world, your entire cryptocurrency portfolio will not be wiped out by the failure of a single coin.
Of course, diversifying your bets has the potential to reduce your gains. However, consider the following. If you have ten coins instead of one, your chances of receiving a trip to the moon are increased, yet you may lose your opportunity of getting transport to Pluto.
Anastasiya Belyaeva, (head of growth at PieDAO), a platform that provides investors with a variety of cryptocurrency portfolios, says that ” investing in smaller coins whose feature is core to the DeFi (decentralized finance) ecosystem in overall is also an excellent way to profit from the future of cryptocurrency.
Disadvantages Of Crypto Diversification
In the same way that diversification decreases risks, it also reduces the ROI (return on capital). It is important to note that the gains earned by your strong assets will be offset by the losses sustained by your other investments.
Bottom Line
Diversification is a smart risk management method that many investors employ to mitigate risk in both traditional and crypto assets. Even though it will not shield you from a market-wide correction or a negative cycle, it will decrease your chances if one of your portfolio assets departs the crypto market or has a poor run in the market.
So remember that investing involves risk, but risks can be mitigated to a certain degree. The effect of global economic occurrences on your portfolio might be considerably reduced if you make more informed investing decisions.