Disclaimer: YouHodler is not a financial advisor. Therefore, do your own research and due diligence before applying any of the techniques highlighted in this article. Any risks or trades based on this article are committed at your own risk.
So, why would you even be bothered with the diversification of your crypto portfolio? Good question! Let’s try to formulate an answer.
Any good trader wants to make a profit. In order to make a profit, you need to take some risks. Often, a correlation exists between risk and profit. The higher your risk, the higher your profit. However, don’t forget about the downside. High risk also implies big losses.
A good example of a high-risk trading strategy is margin trading or Forex. Margin trading allows you to use leverage that multiplies your capital. For example, a 1:50 leverage would mean that you can have a balance of $100 but trade with a balance of $5000. Of course, you can lose your full balance very quickly when a trade goes negative as every move needs to be magnified by a factor of 50.
Therefore, a good trader knows how to manage risks. Actually, trading is all about managing risks while still growing your capital. So, why would you choose for portfolio diversification of your cryptocurrencies?
In short, diversification serves the single purpose of managing risks by mixing a variety of different investment strategies. Your goal is to create a group of investments that exposes your portfolio to as many different areas as possible which helps to reduce the overall risk of your investments. The idea is that your portfolio can withstand negative events without losing too much value in your portfolio.
For example, your portfolio consists of 70% Bitcoin and 30% Ethereum. This is not a well-diversified portfolio. You are only exposed to two investments and both investments are heavily correlated. In case the price of Bitcoin drops, you’ll likely experience a drop in the price of Ethereum. This means your overall portfolio balance will drop which is a serious risk.
Therefore, you want to invest in other solutions that are not necessarily tied to Bitcoin. In case the Bitcoin price crashes, you don’t lose the value of your full portfolio but only half of the value as you were smart enough to diversify between two types of products. For that reason, a well-balanced portfolio will help you to conquer the worst market crashes.
Let’s learn how crypto portfolio diversification can be applied and which techniques exist?
Let’s take a closer look at some examples of crypto portfolio diversification. Here are a couple of possible crypto portfolio diversification strategies:
Each of the below sections explores a use case for the listed crypto diversification strategies. Ideally, you should mix multiple diversification strategies to reduce risks as much as possible.
First of all, let’s learn how we can leverage industry diversification to manage risks. The idea for industry diversification is to expose your portfolio to as many industries as possible. In case a certain industry suffers a big hit, your portfolio can absorb this hit as you applied diversification.
For example, you can invest in cryptocurrencies in the following industries:
It’s even possible to diversify within each industry by looking at how you pick projects. Do you want a mix of well-established projects and projects trying to solve new, emerging problems? Or do you solely focus on projects that try to solve new, challenging problems - innovation-based investment approach?
It’s up to you to determine your values and how you want to invest. However, don’t invest in a project if you don’t know much about a project, its values, or the industry they’re active in. Always do upfront research to get a better understanding of the industries’ challenges and opportunities.
Next, you can invest in different types of solutions or products. For example, you can spread your investments between newly developed blockchain platforms, new protocols, and new tools or services such as wallets or data providers.
By investing in different segments of the blockchain solutions market, you are spreading risks.
Further, you can diversify your investments based on the type of cryptocurrency. One could argue they only want to invest in privacy coins as you see huge potential here.
Other strategies might include investing in different types of coins such as stablecoins via YouHodler’s savings account or utility tokens. Make sure to analyze the different possibilities and how you want to allocate your portfolio.
Lastly, the most simple solution is to include projects from different regions in the world in your crypto diversification portfolio.
For example, Asian blockchain projects often have a big and loyal following which makes them an attractive investment option. Having a large and loyal community determines to some extent the success of a project. However, you can decide to mix your investments with some European and American projects to have a more geographically balanced portfolio.
You may wonder why time diversification deserves its own section? Time diversification is one of the oldest and most proven diversification strategies.
Timing the market is hard. Only with a good amount of luck, you can sometimes time the market perfectly. However, in most cases, it’s hard to determine the right buy-in moment.
The solution is simple. Instead of buying your portfolio at once, you want to buy parts of your portfolio in timed intervals. Let’s say we want to buy 5% of our portfolio every 2 weeks. After 40 weeks, you’ll have bought your full portfolio. The benefit of this timing strategy is that you can eliminate bad timing. As Ben Carlson says, “Time diversification is not the ideal solution, however, it helps you move from short-term guessing to long-term planning.” In addition, it takes the responsibility of poor timing decisions out of your hands. Of course, time diversification is not the perfect solution. Bad timing can’t be eliminated completely.
You can try to reduce risks as much as possible, however, don’t expect to find the golden crypto diversification portfolio. Any sudden event such as the Coronavirus can cause a global market collapse and slash your portfolio nonetheless.
Therefore, remember that investing is risky but you have the ability to manage risks to a certain extent. By making smarter investments, you can drastically reduce the impact of global slashing events on your portfolio.
Do you want to extend your portfolio with a safe investment option? Consider using YouHodler’s savings account which gives you an annual return rate on stablecoins and other cryptocurrencies of up to 12%. YouHodler works by leveraging blockchain technology for peer-to-peer lending crypto. As a lender, you receive fees and interest paid by the borrowers which makes it an ideal passive income for any investor.