Every investor wants to maximize profits while minimizing risk. Several strategies are used to achieve this goal. One is to adhere to the golden rule of investing, “Don’t put all your eggs in one basket.”
Although this advice sounds very simple, its implementation can be complex. How do you determine the right portfolio for you? What should be the basis for adding cryptocurrencies to your portfolio? And there are other such issues that can arise. This blog will guide you through the exact steps of building a diversified portfolio.
What Is Cryptocurrency Portfolio Diversification?
Diversifying your cryptocurrency portfolio means allocating funds to multiple cryptocurrencies or projects to minimize risk and maximize returns.
A good diversification strategy can prevent your portfolio from becoming extremely volatile in case one cryptocurrency falls short. You can also invest a portion of your portfolio in high-risk projects for exponential return opportunities.
For example, if you are a risk-averse investor, you should invest most of your portfolio in more established cryptocurrencies, such as Bitcoin and Ether, and allocate the marginal portion in highly volatile cryptocurrencies.
Reasons to Diversify Your Cryptocurrency Portfolio
Why diversify the portfolio into cryptocurrencies?
Cryptocurrencies are highly volatile. A portfolio focused on one or more similar cryptocurrencies can expose your portfolio to volatility. A sudden decline in them can cause the value of your portfolio to plummet. Diversification can help you build a balanced portfolio, limiting the impact of market volatility on your capital.
At the same time, it helps you take calculated risks. Depending on your risk appetite, you can allocate a small portion of your portfolio to higher risk, higher return assets.
How to Diversify Your Cryptocurrency Portfolio?
Now that you understand the benefits of diversifying your cryptocurrency portfolio. Let’s look at the factors you can consider while while doing so.
Different cryptocurrencies operate on different blockchain models, each with differences in design, security and other factors.
For example, proof-of-work (PoW) and proof-of-stake (PoS) are two of the most popular types of blockchain, and there is often debate about whether one is better than the other. PoW is energy intensive and requires significant computing power to operate. PoS, however, is more energy efficient. However, PoW is considered more reliable than the others. Again, each type of blockchain will have its advantages and disadvantages.
Therefore, it may be wise to diversify cryptocurrency portfolio allocations based on the underlying blockchain network. In the long run, one type of blockchain may have more influence than others.
2. Market capitalisation
Market capitalization is the total value of a cryptocurrency. A large market capitalization indicates that more people are buying a cryptocurrency. This is because the more people buy a cryptocurrency, the greater the demand, price, and therefore market capitalization. Such cryptocurrencies are considered more stable due to investor confidence.
Cryptocurrencies with low market capitalization, on the other hand, are more prone to volatility. They are riskier because the impact of a few investors on the market as a whole can be significant. In addition, these currencies tend to be newer and have not yet been widely adopted. However, should they take off, the rise of these cryptocurrencies could be exponential.
They can be an important factor in portfolio diversification. Therefore, it is possible to have a large, small and medium-sized cryptocurrency portfolio, depending on one’s risk appetite.
High-cap cryptocurrencies are also known as blue-chip cryptocurrencies. To learn more about blue-chip cryptocurrency products, click here.
3. Use case
The most common mistake when building a cryptocurrency portfolio is to compare currencies and tokens based only on price. A token is more important than its price. They are also used for different purposes. Bitcoin, for example, was created to serve as a digital currency and facilitate payments, but it is now used as a store of value. Its value is largely determined by supply and demand.
Ethereum, on the other hand, has a much wider range of applications. The technology behind Ethereum allows developers to create decentralized applications on its blockchain. The value of ETH comes from its utility and the value created by the Ether network.
Other cryptosystems also have a wide range of uses. The value of these cryptosystems is directly related to the utility they provide. To build a balanced portfolio of cryptocurrencies, it is necessary to include many coins with different types of uses.
Different cryptographic machines try to provide solutions for different industries.
The use case of a cryptocurrency is its utility, while a sector is the industry in which a cryptocurrency is used. For example, the use case of ETH is to be used within the Ethernet network for payment services. However, the industry it is targeted at is smart contracts, as it allows for the creation of decentralized applications using its smart contract capabilities. Several cryptosystems and crypto projects offer decentralized solutions in different areas. For example, Bitcoin, Ripple, etc. target the payment industry, while Sander and Gala target the Metaverse, and so on.
This is a typical risk mitigation strategy. It is also used in the stock market where one invests in different sectors, so even if one chooses other sectors to support oneself.
To Sum Up
Diversify your cryptocurrency portfolio by selecting 4-5 sectors based on key trends. Then select 3-4 promising projects or cryptocurrencies in each sector, based on their use cases, market capitalization, and other factors you think are important. This way you will have between 12 and 20 cryptocurrencies that can form a balanced portfolio. If you want a slightly more concentrated portfolio, you can increase the allocation to a few selected cryptocurrencies and remove the others.
But remember to do research before investing. If you do not have the time or resources to perform this tedious task, you can still use a group of coins to execute this strategy. This is a basket of cryptocurrencies compiled by experts based on themes such as NFT, Metaverse, DeFi and others. You can invest in some of these coin sets and you will be good to go.