As cryptocurrencies become more and more popular, many people are starting to invest in them. With the recent Bitcoin boom, cryptocurrency investing has been a hot topic for some time now. But since cryptocurrencies are highly volatile, which means prices fluctuate unexpectedly, investing in them may expose investors to a potential financial risk. This is where crypto portfolio diversification enters the picture.
However, the problem (and the opportunity) is that most people don't know how to diversify their crypto portfolios properly.
Diversifying your crypto portfolio can be a challenge.
There are so many different coins out there, and it's easy to get overwhelmed when trying to decide which ones you should invest in.
Some choose to follow the hype and invest in those cryptos that are trending, like what happens in Dogecoin cryptocurrency, which initially happens to be a meme coin. Dogecoin's price reached its all-time high after Reddit groups and a CEO of an electric car company announced their fondness for dogecoin.
However, the coin's price plummeted after a few months. This is another reason why diversifying your crypto portfolio is essential to minimize the risk associated with sudden and unexpected crypto price movements.
To get an overview of the various ways to diversify your crypto portfolio and which coins or tokens you should invest in, read through this article.
What Is Cryptocurrency Portfolio Diversification?
Diversifying your cryptocurrency portfolio means that you invest in different coins and tokens to hedge against their price changes.
The idea behind diversification goes like this: If Bitcoin's price drops drastically, then some altcoins (alternative coins), like Ethereum, Litecoin, and Tron, might appreciate on the same event, or at least drop much less.
Generally, diversifying crypto investments comes with some benefits. For instance, diversification gives investors protection against financial risk, as well as an opportunity to explore various types of coins and projects and attain a better profit performance. Remember, having a diversified cryptocurrency portfolio means that you have the flexibility to enter various crypto markets and that you’re less susceptible to incurring significant investment losses.
Hence, to effectively diversify your portfolio, you should invest in more than one coin or token. Ideally, you will choose several cryptocurrencies with different fundamental values or with different potential valuations.
Let’s explain that.
1. Diversify by Value: Invest In Coins With Different Use Cases
Each cryptocurrency is created with a purpose.
Some are used as a digital currency for fast and easy transactions worldwide without involving third parties, while others are designed to be used as a digital store of value.
For example, Bitcoin and Monero were created for use as alternative currencies; Ethereum is built for smart contracts and launching new tokens by projects, which have their own ICOs (Initial Coin Offerings).
Since each cryptocurrency has its specific purpose, or fundamental value, it's more efficient to diversify your portfolio by dividing investment funds between different industries.
This method does require a lot of research. In the age of DeFi, it also requires understanding of the technology behind each cryptocurrency.
One thing that’s pretty much set in stone is that in diversification by fundamentals you should definitely avoid pump and dump coins.
2. Diversify by Valuation: Diversify Based On Cryptocurrency's Project Location
A cryptocurrency's project location is also a good indicator of whether or not it's worth investing in.
Investing in projects located in regions with more leeway in crypto investing may be more convenient and cost-effective than other regions.
Keep in mind that there are countries that either put restrictions or completely banned crypto projects - a prominent example is BlockFi getting cease and desist order in July 2021.
With this, always check if the project has necessary licenses and avoid investing in any project from a country that has banned cryptocurrencies, even if the coin itself is legal in other countries. This is to avoid any future legal trouble associated with your cryptocurrency investments based on a certain project location.
Another aspect that is heavily influenced by the project’s location is its potential valuation. The number of loyal followers of a crypto project might depend on its location and marketing. Remember that a country where crypto is already widely used may succeed faster than in countries with less adoption.
Indeed, there are effective ways to make a diversified crypto portfolio. But aside from the ones mentioned above, you can diversify your investments through a crypto Individual Retirement Account (IRA). When you buy crypto in an IRA, you have the opportunity to protect your financial holdings against economic issues.
If you’re looking for a financially comfortable life after retirement, making an investment in a crypto IRA will be a wise decision. Even if there’s inflation, you’ll have nothing to worry about because crypto investments in your IRA aren’t affected by the price fluctuations associated with traditional investments. So, if you’re planning to diversify your portfolio with a crypto IRA, check out some reliable resources online to know how and where you can start.
Make A Plan For How Much To Invest And For How Long
Before you start buying cryptocurrency, make a plan.
- How much money can you afford to invest?
- Under what market conditions are you going to execute your buying positions?
- Will you buy at once or DCA?
Timing the crypto market isn't easy, even for experts. It might be worth waiting for a dip in the market, but the market can always turn the other way while you wait.
What you can do is make a list of the cryptocurrencies you want to invest in and set up price alerts. This way, you'll be updated each time the market reaches your target price.
If that sounds like way too much time and stress, then dollar cost average and leave out the whole issue with market timing.
Assess the risks coin by coin
Efficient capital allocation is a system of determining what investment projects are less or more risky than others.
If you're just getting started, it might be good to start with a currency that is already established and fluctuates relatively little, like Bitcoin. Or, if you come from legacy investing, you can absolutely buy precious metals as a base.
By doing so, you'll at least have one pretty stable base. That is always a good idea in any portfolio.
Once you have that, you can venture into smaller and riskier crypto coins.
Unless you’re going for a very short term speculation, do not put a significant percentage of your overall holdings into coins without much trading volume or history yet.
This is just a rule of thumb. It's not necessarily going to be perfect for every person or scenario: If you want some wild speculation, go for it (within reason).
But the goal of diversification is that you invest in a bunch of coins out of which some appreciate, some decline, some shoot up and one or two may fail - which is not going to be the end of your world because you have already made money on the other coins.
Cryptocurrency markets are volatile.
If you don’t want to get hit with massive drops on your portfolio but you’re not into active trading either, diversifying is your best option.
Adequate diversification can be done by investing in more than one cryptocurrency after understanding its fundamentals. If you’re looking at more classical options and deciding between investing in cryptocurrency or precious metals as an alternative, always consider the risk-reward ratio of where you invest your money.
No matter what you choose to do, make sure that it's a strategy that works for you. Also, don't get too caught up in 'pump-and-dump' schemes.