Cryptocurrency is a new and emerging asset class that has now grown rapidly since the past few years. Seeing the adoption, new investors are surfing the internet on how to start their crypto investing journeys. To get you started, it is vital to understand how does crypto fit in a retail investor’s portfolio and then how to build a crypto portfolio to get the best risk-adjusted returns from this asset class. With a range of options today, such as buying individual coins and tokens, crypto ETFs, crypto baskets and so on, building an ideal crypto portfolio has never been easier. Let’s explore how to build a cryptocurrency portfolio for a retail investor in this article.
What is a Crypto Portfolio?
Before answering how to build a cryptocurrency portfolio, let’s understand what a crypto portfolio means. Just like a traditional investment portfolio, a crypto portfolio is a collection of multiple cryptocurrencies working in same or different sectors, bundled together to suit an investor’s risk profile. The goal is to provide better risk-adjusted returns. It is vital to have a healthy mix of good tokens or coins to build your crypto portfolio, depending on your risk appetite and investment horizon.
Now that you know what a crypto portfolio means, there are a few things you must consider before we tell you how to build a cryptocurrency portfolio. These will help you begin with your initial crypto portfolio allocation:
Altcoins and the associated FOMO
Altcoins refer to all coins apart from Bitcoin. There are plenty of altcoins in the crypto market. During a crypto bull run, altcoins may outperform Bitcoin. A lot of retail investors and traders FOMO (fear of missing out on the exponential gains) into altcoin rallies during these times. However, during the meltdown, altcoins are the first to vanish as well. Hence it is important to understand the risks involved with them. To give you context, most of the top 15 cryptocurrencies from 2017 are not even in the top 100 list today. So, doing your part of research before investing is a must.
Long term investment
It takes patience and discipline to build a well balanced and strong cryptocurrency portfolio as the crypto market is highly volatile. To avoid panic moves, it may be a good idea to practice dollar-cost averaging.
Once you have chosen your mix of cryptos (more on this later in this article), it is a wise option to invest in them periodically. You could do that through a Systematic Investment Plan or SIP. It can help you take advantage of the market downturns by averaging the cost of your investments.
How to allocate crypto in your portfolio?
To build an ideal crypto portfolio, you must understand the different types of portfolios. As we discussed, the importance of cryptocurrency diversification is vital. Learn more about it here.
Concentrated vs diversified crypto portfolios
First of all, there are two types of crypto portfolio allocations – concentrated and diversified.
A concentrated crypto portfolio is when you invest in either one or a handful of cryptocurrencies of the same sector. Let’s say your portfolio only has Bitcoin, so now your entire crypto portfolio is dependent on a single cryptocurrency. If Bitcoin drops by 50%, half of your portfolio wiped out.
On the other side, let’s say you have invested in 5 different cryptocurrencies of the same theme, for example, DeFi. Though you may think this is a diversified portfolio, it is not, as all of your cryptocurrencies are tied to a single theme. And if DeFi takes a hit, your entire portfolio would be at risk.
A well-diversified crypto portfolio consists of crypto assets across different sectors. It can help you in giving out risk-adjusted returns during high volatility.
An example of this might look like you are investing in Bitcoin, Ethereum, a few altcoins with different and specific use cases, and perhaps a couple of NFTs too. However, the exact mix of this crypto allocation would be different for all and based on their risk appetite.
Different types of cryptos
Now that you know how to diversify your crypto portfolio. Let’s take a look at the different types of cryptos you can choose to invest in:
- Payments Coins
Bitcoin, which pioneered the crypto industry, is an example of a payment coin. These are primarily used as a medium of exchange. Payment coins are truly digital currency. Cryptos like Ripple, Litecoin and Bitcoin Cash are payment coins.
A stablecoin is a crypto which is usually pegged to a fiat currency (like the US Dollar) or a precious metal (say silver or gold). PAX Gold (PAXG) is a coin which is pegged to one fine ounce of gold that is held in reserve. While BUSD is an example of a stable coin which is pegged to the US Dollar in a 1:1 ratio.
Due to this pegging nature, stablecoins are almost non-volatile (there have been instances in the past where this is not true) than their counterparts. Hence the word stable in them, duh! Although they are not completely free from risk, adding them to your crypto portfolio can help you when the market is dipping and you can instantly convert these stablecoins to buy more of other coins in your portfolio.
- Security tokens
A security token is a crypto asset which may possess some properties of a traditional asset. For example, it may represent ownership in the project (like equities), or it may carry the voting rights of a company. In simple words, security tokens are just traditional securities which are digital in nature and put up on the blockchain.
- Utility tokens
By definition, a utility token is a cryptocurrency which is issued by a crypto project to fund itself. This happens via coin offerings. These tokens serve utility in that crypto ecosystem and hence derive their name from it. These tokens may be used to pay for goods and services of the project or any such other utility.
So theoretically, the value of utility tokens should be equal to the value of utility they can provide to investors like you and me. For example, ETH can also be a utility token as one can pay a transaction fee with ETH on its blockchain while interacting with applications on it.
- Governance tokens
Governance tokens have 2 common properties with equity. Just like equities, governance tokens may carry voting rights and a share of the profits for the said crypto project. This is a unique and decentralized way of distributing the power to vote on major platform changes for any blockchain community.
Technically, the owners of governance tokens are not just its users but also owners of the underlying blockchain protocol.
Here are 6 strategies to diversify your crypto portfolio:
- Buy cryptocurrencies with different use cases or segments
- Invest in different cryptocurrency blockchains like Ethereum, Solana, Polygon, etc.
- Use market capitalization as a diversification tool as well
- Diversify crypto projects based on the location (country) as well
- Invest in crypto projects that belong to different sectors
- Diversify according to your risk appetite – lower the risk, higher the diversification.
You now have everything you need to build a cryptocurrency portfolio.
How to build an ideal crypto portfolio?
Here is a step by step guide to building your ideal crypto portfolio:
Open a crypto investment account
The first step to creating a crypto portfolio is to get registered with a crypto broker or a crypto exchange and open your account. This will include the KYC and other regulatory processes as per their norms. It is wise to do your research before selecting your broker/ exchange as they vary in liquidity, transaction fees and other product offerings.
Assess your risk appetite
Map out your risk profile. This means that you need to assess yourself and understand what level of risk you are comfortable with. If you want a moderate return but do not want to lose much in the worst case, you can categorize yourself as a low-risk investor.
On the other hand, if you want exponentially high returns and are willing to lose some money in the process or for the time being, then you are a high-risk investor. Craft your crypto investment strategy accordingly.
Decide on overall asset allocation
After you have assessed your risk level, you can now easily decide on the asset allocation. Asset allocation means what portion of your entire portfolio will be in cryptos. Ideally, if you are a low-risk investor, you should start with small investments and keep increasing the amount time to time.
Ultimately you should ask yourself the question – how much exceptional returns am I seeking by investing in crypto? And the answer to that should be how much you allocate to your crypto portfolio.
Research and study the different coins / tokens
Do not skip the hard part. Deciding your risk appetite and allocation level is simple. No matter if you’re investing 2% or 10% of your portfolio in cryptos, if you do not conduct your own research and fly by social media trends and hype, you are most likely to wipe out your entire crypto portfolio within a year.
On the other hand, if you can conduct your own research, market volatility cannot scare you. And this will motivate you to be patient and reap long term returns on your investment. Always remember, for a retail investor – the best crypto portfolio is the well-balanced one and a diversified cryptocurrency portfolio.
Rebalance your portfolio
Just like we do in our equity portfolio, we need to rebalance our crypto portfolio as well. Due to high market volatility, there may be disproportionate movements in your different crypto assets. Take time in regular intervals (say quarterly or yearly) to rebalance your crypto portfolio as per your original investment thesis.
Follow an investment style – SIP
Finally, if you are not comfortable putting your money in crypto’s lump sum or want to make better use of market volatility, you can follow a SIP style investment plan wherein you can invest a small portion into crypto every month. This will help you with dollar-cost averaging during the market downturns and will slowly build your confidence in the tokens you will invest in. Even if you are not a low-risk investor, this is a great strategy to invest in cryptos, given its high volatility.
Now that you are fully equipped to answer – how to build your cryptocurrency portfolio? Here are some of the frequently answered questions.
What is a balanced Crypto Portfolio?
A balanced crypto portfolio is a collection of crypto assets (coins, tokens, NFTs) which reduce the risk of market volatility on your crypto investments, positioning it better to reap higher risk-adjusted returns.
How big should your crypto portfolio be?
The shortest answer to this question is – your crypto portfolio should be equal to the amount of money that you are comfortable losing altogether. As mentioned above, there is high market volatility. While your crypto investments may not completely wipe out, they can nosedive 70% within a month in some cases. Hence, it is advisable to allocate only that amount that won’t make you panic and sell during such tough times.
This blog is a complete guide for those wondering about how to build a cryptocurrency portfolio. Diversification is the key to an ideal crypto portfolio like in your traditional portfolio. It is important to understand the different types of crypto assets. You need to develop your research and investment strategy based on your risk appetite. It goes a long way. And finally, do not fall prey to the online gurus wanting to make you rich with cryptos overnight. For new investors, investing in a diversified crypto baskets called Coin Set can be best. The tokens in the basket are managed by experts ensuring risk-adjusted risks.