Every investor aims to maximize profits while minimizing their risks. You can use multiple strategies 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 put this into practice. 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. In this blog, we will walk you through the exact steps of building a diversified portfolio.
What Is Cryptocurrency Portfolio Diversification?
Crypto portfolio diversification basically involves allocating your capital in multiple cryptocurrencies or projects with the aim of minimizing risks and maximizing returns.
A good diversification strategy prevents your portfolio from extreme volatility in case a 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 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 few similar cryptocurrencies may put your portfolio at risk of volatility. A sudden dip in them may drastically bring dowm 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 how you can diversify your portfolio.
1. Blockchain
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 extremely energy intensive and requires huge 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 cryptocurrency portfolio allocation based on the underlying blockchain network. It may happen that a certain type of blockchain may turn out to have leverage over other in the long run.
2. Market Capitalisation
Market capitalization refers to the aggregate value of a cryptocurrency. Higher market capitalization is achieved when more people buy a crypto, indicating investor confidence and vice versa. Hence, large market cap cryptos are considered more stable while low market cap cryptos experience extreme volatility.
Low market cap coins are usually newer coins which have not yet been widely adopted. They do possess a higher risk but the upside in those coins could be exponential..
The coins with the highest market capitalisation (like Bitcoin, Ethereum, etc.) are also known as the blue-chip cryptos. Blue-chip cryptos are essentially the highest valued cryptos which have less market volatility compared to other altcoins. 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 purely act as a digital currency to facilitate payments and is now turned into a store of value. Its value is driven by demand and supply to a large extent.
Ethereum, on the other hand, has a wider use case to it. 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, not just based on demand and supply basis.
Similarly, there are other cryptos which 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.
4. Industry
Well, if the use case of each crypto can be different, it is highly likely that there are different industries that different cryptos are trying to tackle. The use case of a crypto talks about its utility while industry refers to a sector that a crypto is trying to solve for.
For instance, ETH’s use case is that it can be used within the Ethereum network to pay for services. But the industry that it is solving for is Smart Contracts because it is enabling people to create decentralized applications using its smart contracts functionality. Different cryptos and crypto projects are based on providing decentralised solutions across various industries. Cryptos like Bitcoin, Ripple etc are solving for the payments industry while Sand, Gala are solving for Metaverse and so on and so forth.
This is a classic strategy to mitigate risk which is also widely used in the equity markets. You invest in different sectors so that even if one takes a hit, you are invested in other sectors too.
To Sum Up
To diversify your cryptocurrency portfolio select say 4-5 industries based on the mega trends. Then pick 3 to 4 projects or cryptos in each industry that has potential based on 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 make use of 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!
