Every investor aims to maximise profits while minimising their risks. There are multiple strategies used to attain this goal. One of them is to abide by the golden rule of investing, “Do not put all your eggs in one basket”.
While this advice may seem very straightforward, it may be complicated to implement. How should you be deciding the right portfolio mix for yourself? What should be the basis for adding cryptos to your portfolio? And more such questions may come. This blog will walk you through the exact steps of building a diversified portfolio.
What Is Cryptocurrency Portfolio Diversification?
Crypto portfolio diversification involves allocating your capital to multiple cryptocurrencies or projects to minimise risks and maximise returns.
A good diversification strategy prevents your portfolio from extreme volatility in case particular crypto performs poorly. It also enables you to invest some part of your portfolio in higher-risk projects for a chance to yield exponential returns.
For instance, if you are a risk-averse investor, you would want to invest the maximum of your portfolio in more established cryptocurrencies like Bitcoin and Ethereum and allocate a marginal portion to extremely volatile cryptocurrencies.
Reasons to Diversify Your Cryptocurrency Portfolio
Why should you diversify your crypto portfolio?
Crypto assets are highly volatile. Having a concentrated portfolio with either one or a few similar cryptocurrencies may put your portfolio at risk of volatility. A sudden dip in them may drastically bring down your portfolio’s value. Diversification can help you build a balanced portfolio and reduce the impact of market volatility on your capital.
Simultaneously, it also helps you take calculated risks. Based on your risk appetite, you can dedicate a small portion of your portfolio to high-risk – high-reward assets.
How to Diversify Your Cryptocurrency Portfolio?
Now that you understand the benefits of diversifying your cryptocurrency portfolio. Let’s look at the factors you can consider while while doing so.
Different cryptocurrencies work on different blockchain models—each varying from another in terms of design, security and other factors.
For instance, Proof of Work (PoW) and Proof of Stake (PoS) are two of the most popular blockchain types, and it is often debated that one is better than the other. PoW is energy-intensive and requires substantial computational power to operate. While PoS is more energy efficient. However, PoW is considered to be more reliable than another. Likewise, each blockchain type will have its pros and cons.
Hence, it might be wise to diversify your crypto portfolio allocation based on the underlying blockchain network. A specific type of blockchain may turn out to have leverage over others in the long run.
2. Market capitalisation
Market capitalisation refers to the aggregate value of a cryptocurrency. Large market cap is an indication of more people buying a crypto. Because the more people buy a crypto, the greater demand it has, pushing its price and thus the market cap higher. Such cryptocurrencies are considered more stable because of investor confidence.
Whereas, low market cap cryptos are more volatile. They possess greater risk because the impact of a few investors on the overall market could be significant. Additionally, these coins are usually newer coins which have not yet been widely adopted. However, if they take off, the upside in such cryptos could be exponential.
It could be a great factor in diversifying your portfolio. Accordingly, you can have a mix of large, small and mid cap cryptos, based on your risk appetite.
High market capitalisation cryptos are also known as the blue-chip cryptos. You can read more about blue-chip cryptos here.
3. Use case
The most common mistake while building a crypto portfolio is comparing the coins and tokens based on price alone. There is more to a coin than just its price. They differ from each other in terms of their use cases as well. Bitcoin, for example, was created to act as a digital currency and facilitate payments but is treated as a store of value now. Its value is driven by demand and supply to a large extent.
Ethereum, on the other hand, has a broader use case. Ethereum’s underlying technology enables developers to build decentralised apps on its blockchain. This makes Ethereum a decentralised network, not just a digital currency. The value of ETH is derived from its utility and the value the Ethereum network creates.
Similarly, other cryptos have a wide range of use cases. And the value of these cryptos is directly tied to the utility they provide. To construct a well-balanced crypto portfolio, you should include multiple coins with different use cases.
Different cryptos are trying to solve for different industries.
The use case of a crypto talks about its utility, while industry refers to the sector a crypto is working towards. For instance, ETH’s use case is that it is used within the Ethereum network to pay for services. But the industry it is solving for is Smart Contracts because it enables people to create decentralised applications using its smart contracts functionality. Different cryptos and crypto projects provide decentralised solutions across various industries. For example, Bitcoin, Ripple etc., are solving for the payments industry, while Sand and Gala are solving for Metaverse and so on.
This is a classic strategy to mitigate risk. It is also used in equity markets where you invest in different sectors so that even if one takes other sectors back you up.
To Sum Up
Select 4-5 industries based on the mega trends to diversify your crypto portfolio. Then pick 3 to 4 projects or cryptos in each sector that has potential based on their use case, market cap, and other factors that you may think are important. This way, you have 12 to 20 cryptos that can form a well-balanced portfolio. If you want a slightly more concentrated portfolio, you can increase your allocation in a few of the selected cryptos and cut off others.
But remember to do your research before investing. If you do not have the time or resources to do this tedious work, you can still implement this strategy using Coin Sets. They are a basket of cryptos curated by experts based on the themes like NFT, Metaverse, DeFi etc. You can invest in a few such Coin Sets, and you are set to go!