Why and How to Diversify Cryptocurrency Trading Portfolio
Why is it necessary to diversify an investor’s cryptocurrency trading portfolio? What are the different strategies for a diversified crypto portfolio?
Bitcoin is considered to be one of the top-performing assets to date. In the past, Bitcoin has been named as the best performing asset of the decade; beating the traditional financial instruments like gold, stocks, bonds, etc. In the year 2020 alone, this cryptocurrency delivered a return of nearly 300%. In 2020, we also saw a number of institutional investors, hedge fund managers, and asset managers diversifying their trading portfolio and including a percentage of Bitcoin alongside bonds, stocks, equities, etc.
While prominent cryptocurrency assets including Bitcoin and Ethereum gained recognition in 2020, the digital currency space has moved far beyond the top ten assets. The markets now incorporate more than 8000 coins based on different use-cases, properties, utility, and features. In this article, we seek to understand why it is necessary for an investor to consider diversifying a cryptocurrency trading portfolio which incorporates a multitude of digital currencies. We also understand the strategic methods that may be employed to build a diversified crypto portfolio.
Why Diversify Your Cryptocurrency Portfolio?
A diversified crypto portfolio refers to the act of investing in multiple digital currency tokens to reduce the factor of risk in the event that one or more failed to perform. The basic aim of diversification is to lower the impact of negative events by not putting all your eggs in one basket. Investors who invested in Bitcoin during the 2017 bull run received a sharp blow when the price of Bitcoin fell by more than 50% in 2018.
By investing in multiple cryptocurrencies, investors can protect themselves against such negative events. Moreover, a diversified cryptocurrency portfolio also presents an opportunity to leverage the volatility in coin prices and also invest in cryptocurrency projects, at a fairly low valuation, that can yield massive returns. Hence, the best-diversified crypto portfolio facilitates mitigating risks and increasing the chances of yielding returns from cryptocurrency investments.
Crypto Diversification Strategy: How to Diversify Your Crypto Trading Portfolio?
Investors diversify their trading portfolio depending upon different aspects, depending upon an individual’s preference. Crypto diversified strategies include a mix of coins based on risk-factor, property, type of tokens, functionality, and more. In this crypto diversification strategy, we have divided assets based on their properties and functionality.
1. Diversification Based on Industrial-Use Case
The landscape of blockchain incorporates multiple use-cases from different industries including real estate, healthcare, finance, supply chain, governance, and more. Decentralized applications belonging to different use-cases are built on the blockchain network. These dApps employ a utility token based on their ecosystem. The valuation of these altcoins is proportional to the success or failure of the project.
Along with including safe assets like Bitcoin and Ethereum, such altcoins facilitate a trader with a chance to invest in a blockchain project at a low valuation. In the next few years, as the technology matures, it is likely that some of these projects will yield huge returns. Investors can include some of these tokens in their cryptocurrency portfolio to leverage long-term benefits from these projects.
2. Diversification Based on Solutions
In this part of the strategy, investors include coins that facilitate new protocols, solutions in an existing industry, and service providers in the crypto and blockchain space. Solutions in the cryptocurrency industry may include new protocols like DeFi, crypto exchanges, wallet service providers, etc. By including a percentage of investment in solution-based cryptocurrencies, an investor leverages the growth in the supportive infrastructure in the blockchain ecosystem.
Furthermore, as the industry enters mainstream adoption such solutions are likely to gain substantial growth. Investors can leverage this opportunity for long-term investment and stability in their trading portfolio. Moreover, if one or more solutions are likely to click, investors can also expect substantial returns. For instance- Newly introduced DeFi protocols yielded returns of more than 600% in 2020 alone.
3. Diversification Based on Inherent Property
The space of cryptocurrencies has expanded to a multitude of tokens with different inherent properties and catering to different functionalities. Tokens are segregated based on their properties like privacy coins, stable coins, staking coins, etc. It is likely that one or more of these segments are likely to gain popularity in the next few years.
For instance, traders have started leaning towards privacy coins and the rising trading volume may bring a surge in demand for privacy coins. Furthermore, staking has become a popular activity for passive investment in cryptocurrencies. Investors stake cryptocurrency tokens that allow them to yield a steady return. The market of stablecoins has more than doubled in 2020 as investors increase their crypto holdings in stablecoin investment. Stablecoin investment also protects an investor against sudden volatility in cryptocurrency prices.
4. Diversification Based on Geography
One of the aspects of a crypto project affecting its popularity is based on the geographical location. Crypto diversification strategy enables assigning a percentage to coins based on their geographical regions. For instance, some projects in Asia have a larger community of people. A larger community has a certain factor of impact on the success or failure of the project.
With this factor, it may be advantageous to mix projects belonging to different geographical regions like Asia and Europe. This helps in creating a balanced crypto portfolio based on regional impact.
Bitcoin and Ethereum continue to remain the top prominent investment assets in the cryptocurrency markets. However, cryptocurrency projects and protocols subsequently hold the potential for unprecedented growth in the next few years. Moreover, diversifying a crypto trading portfolio facilitates a trader with instruments that help mitigate risks and subsequently increase the potential for returns.
While the space of digital currencies holds potential, diversifying with strategy helps a trader to leverage the space with maximum potential.