Diversification in investments is critical. Your crypto portfolio should only form a portion of your overall investment portfolio. Experts generally recommend that high-risk investments like crypto should make up no more than 10% of your overall investment. And, regarding cryptocurrency as an investment vehicle, you must diversify your specific holdings too. Don’t hold all of your crypto as Bitcoin, or even as a single coin type, like meme coins.
Investing In Crypto
Investing in cryptocurrency does carry risk, due to its volatility, but that same volatility also carries huge potential gains. With investment in a few cryptocurrencies, it is possible to post significant gains on your investment. But, you do need an exchange account, a willingness to research, an agile investment approach, and at least one of the best crypto wallet apps.
A crypto wallet stores the private keys to your crypto holdings, without which you can’t sell your cryptocurrency or liquidate it for cash. However, different wallets are compatible with cryptocurrencies, tokens, and other digital assets, so you will likely need at least two wallets.
Why Diversify?
When Bitcoin launched in 2009, and for several years following this, Bitcoin was the only cryptocurrency available. Most of us have read reports of early investors turning a few dollars into millions of dollars, but we’ve also read reports of scams and people losing almost all of their investments through ill-timed trades.
Protect Against Scams
One of the reasons you should hold different cryptocurrencies is to avoid scams. Unfortunately, although the market has matured, scams are still present in crypto. Get caught by a rug pull and you stand to lose 90% or more of your holdings. Get caught up in an exchange scam, and you could lose everything. Diversify trades across different exchanges, holdings in different wallets, and your portfolio in different coins.
Protect Against Volatility
The reason that early investors were able to turn dollars into millions was because of the level of volatility present in the cryptocurrency market. And, even as Bitcoin hovers around the $100,000 mark, this volatility remains. Unfortunately, volatility means prices come down as well as go up. Diversification can help protect against big price drops in individual coins.
The Pitfalls Of Diversification
Although diversification is always recommended, there are some pitfalls to this method of portfolio management.
Potentially Lower Returns
If you split your crypto investment across six different coins, and one of those coins suddenly sees 10x returns, your diversified portfolio may only increase 2.5 times compared to if you had all of your holdings in that one coin. Diversifying smooths all spikes, including the profitable ones.
Greater Tax Requirements
Proper diversification requires that you sell out of coins that see significant gains, using the money to increase your holding in other coins or add entirely different coins to your portfolio. Regularly buying and selling coins means you have to track how all of your trades perform, and report these for tax purposes, potentially making it a lot more complicated.
Increases Research Requirements
The potential for scams and the fact that many areas of cryptocurrency are still emerging means that investors need to conduct a lot of research. As well as researching the market, and all potential crypto coin investments, you will need to research brokers, wallets, and other software.
How To Diversify
Generally, the pros of diversification outweigh the cons. But, diversification doesn’t just mean picking any ten coins and buying some of each. You should diversify your portfolio, considering the following methods of diversification.
Crypto Classes
There is an increasing range of cryptocurrency classes available. Coins can range from utility coins like Ether to privacy coins like Monero and meme coins like Doge. There are even NFTs, which may be worth consideration, as well as gaming coins, governance coins, and stablecoins. Bitcoin is a store of value coin, and so too are some of the forks that directly branched off the Bitcoin network.
By Coin
Just because you have invested in a single privacy coin, doesn’t mean you will benefit when privacy coins have their breakout moment. Consider investing in a portfolio of different privacy coins to gain exposure to the coin type while minimizing risk and maximizing potential.
Coin Size
Many investors stick to the biggest and best-known cryptocurrencies. While the likes of Bitcoin still has volatile prices, they are less prone to the huge swings of new coins and those with lower market caps. If you want to invest in smaller coins, keep these investments to relatively small sizes because these coins carry the greatest risks.
Industries
As well as being classified as different coin types, cryptocurrencies can also operate within different industries. Gaming coins operate in the gaming market, but utility coins can be found in healthcare, real estate, and even in collectable whiskey or fine art. Look at the use cases of coins, as well as the industries where they have existing deals in place.
Coin Location
Cryptocurrencies are borderless, which means they can be sent and received from any territory. However, they are usually established or are most popular in certain locations. If cryptocurrency regulations are suddenly introduced in that location, and these negatively impact the asset class, this could lead to the prices of coins in that location dropping. Diversify your crypto portfolio by including coins from different parts of the world that are popular in different locations.