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How to Diversify Your Crypto Investments

Crypto investments

July 24, 2020 | 

JOHN K MWANIKI |  0 Comments| 

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The cryptocurrency market is infamously volatile. This is both negative and positive. On one hand, it presents lucrative investment opportunities to flexible investors.

However, sometimes, risk-seeking investors might be hypnotized by the unhindered profit potential offered by cryptocurrencies, thus going all in. While this approach might mint you huge margins in record time, it can also expose you to severe risks. Savvy investors understand that.

Last year, we witnessed a massive influx of capital into the crypto space, mainly driven by tales of cryptos having minted millionaires.

True, Bitcoin traders outperformed most investors in the traditional asset classes that year, with a 95% value rise. Not surprisingly, most investors from traditional markets are now including Bitcoin (BCT) and Ethereum (ETH) in their portfolio, as they are easy to get into. But that is not enough.

Keeping two popular assets in the same portfolio might gain you more wealth if both of them move in a positive direction, but the loss will be severe if things work in the reverse direction.

So, it is better off to build a portfolio with negatively correlated assets.

To achieve the best returns, you should execute a diversification strategy driven by research. In the next section of this post, we will discuss various ways on how to diversify your crypto investments.

What Is Crypto Portfolio Diversification?

Portfolio diversification is a coated way of saying spread your investment in different asset classes. In other words, do not put all your eggs in the same basket.

For example, if you were to invest all your money in BTC, the value of your investment could fluctuate, leaving you with a huge gain or loss. But if you were to spread it over, let's say, BTC, XRP, ETH, LTC, and BCH, you could reap from the potentially strong performance of BTC, while minimizing its losses by spreading your investment into cryptos with a bright outlook.

Some might want to argue that popular altcoins are linked to Bitcoin, making it hard to diversify a crypto portfolio. But that is the case if you look at crypto portfolios from a narrow lens.

With a well-balanced basket of carefully-chosen stablecoins and altcoins, you could profit more steadily with minimized risks.

Why Diversify Crypto Portfolio?

No doubt, the crypto space is very volatile and often driven by speculation, so managing a non-diversified portfolio can expose investors to unexpected losses.

Sure, diversification might not guard you against a bear market or a market-wide correction, but it will reduce your risk significantly in case an asset in your portfolio falls in value or exits the market.

Apart from this, investors can also diversify their portfolio to grow their investment in a bull market. If you adopt a progressive yet balanced diversification strategy, you increase your chances of profiting significantly from high-growth coins.

But you should also note that some crypto portfolios are not worth diversifying. For instance, if you have set aside $100 for crypto investments, it wouldn't make much sense to spread that amount into several digital currencies or tokens.

If you are working with less than $500, then it is better to play with only 2-3 cryptos. Diluting your portfolio with $50 stakes in 10 different cryptos will not generate desired results, even if you hit gold in both of them.

Remember, there are applicable fees associated with these investments. Managing several small investments is also time-consuming for nothing.

How to Diversify a Crypto Portfolio?

There are various ways to diversify your crypto portfolio, but the most straightforward one should be guided by the following composition:

•    Gambling stake should not exceed 10%
•    Allocate about 30% to moderately risk stakes
•    Safe stakes should take up about 60%

Here, safe stakes are more stable cryptos such as Ether and Bitcoin. They are not entirely safe per se, but they are moderately stable than other cryptos. Your goal should be to include at least a few stable coins that are likely to increase in value over a long period.

Besides the safe stake, include a few medium-sized altcoins. Try to target those with active development, probably those with a market cap of about $100 - $500 million. Potential picks for moderately stable stakes include Stellar, EOS, and Decred.

As for the gambling stake, narrow it to a few speculative tokens or altcoins, which are mainly offered through ICO.
Alternatively, you could also approach your diversification by combining cryptos with different return models. The three main return models are:

•    Staking coins: coins like Dash allow you to execute different tasks to qualify for extra income. For instance, you can secure the networks to earn an extra return.
•    Passive holding coins: These coins let you generate a return by holding a coin for an extended time in the hope of value rise.
•    Interest-bearing coins: Deviant-generating coins reward you when you hold a coin for a specified time. It works the same way as dividend stocks.
To build a crypto portfolio using any of the above approaches, you need to register in major exchanges like Binance and Kraken.

Major Coins to Diversify

As you craft your diversification strategy, it is also important to understand the purpose and potential of each coin. Here are four major groups of coins.

1. Bitcoin
While BTC is a single digital currency, it deserves special attention, as it is the grand-daddy of most cryptos. Moreover, it controls a significant market cap. It is also among the top in terms of the trading volume.

This also means that it is among the most volatile cryptos, but it is worth including in your portfolio.

2. Ethereum and ERC-20 Tokens
Ethereum is the most traded crypto in the market today and the second most valuable when it comes to market cap, after Bitcoin. But it is not a standalone coin. Several tokens run on its ERC-20 protocol including, Waves, EOS, and NEO. Nevertheless, ETH is still the most popular.

3. Stablecoins
To regulate the volatility associated with the crypto market, investors often include stablecoins in their portfolio. They can offer relief in times of market stress. Most of which are backed by fiat currencies or real-world assets. The most common stablecoins are USD Coin, Tether, Paxos, and Libra.

4. Passive Income Earners
Cryptocurrencies markets borrow a lot from the stock markets. Just as there are interest-bearing stocks, there are also interest-bearing coins. You should include some of them in your portfolio to earn you passive income.

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