The debut of Bitcoin in 2009 familiarized millions of persons with crypto. BTC’s standing as a decentralized digital currency encouraged enthusiasts convinced that cryptocurrency could replace fiat currencies. The sharp price fluctuations have enticed day traders and long time investors looking for additional assets for their portfolios.
Currently, traders have more than over 18 000 crypto of value for investors to choose from. DOGE and SHIB showed how a new cryptocurrency can rapidly gain momentum and generate staggering returns in a very short timeframe.
Allocating funds among several different digital currencies provides additional profit opportunities. Many investors are diversifying their cryptocurrency holdings just as they do in the world of stocks and bonds.
What is diversification of a crypto portfolio?
Diversification of a portfolio enhances growth potential and reduces risk. As part of a diversification strategy, investors open positions in large cryptocurrencies such as Bitcoin and ethereum and allocate funds among smaller altcoins.
A portfolio monitor keeps track of cryptocurrency prices while allocating assets. Some investors keep only Bitcoins within those crypto portfolios. Should Bitcoin go up, the trader will earn a return. But the price of BTC could also fall by 50%, causing a Bitcoin-only portfolio to lose significant value.
Buying several digital currencies mitigates the downside risk. During periods of Bitcoin market downturns, smaller cryptocurrencies may only fall by 10%. Individual altcoins rise in price growth even as the wider crypto marketplace falls. An altcoin can double in value in a time when the price of Bitcoin rises by only 20%.
Advantages of diversifying a crypto portfolio
Diversification of a portfolio is well established in the stock and bond market. The pros of diversification of a portfolio involve:
- Lower risk: you are no more dependent on a lone crypto. While a single one of your cryptocurrencies may generate minimal returns, others mitigate losses. You can further diversify your portfolio with other kinds of holdings, like bonds and stocks.
- Growth potential: Bitcoin has a strong market position, but many altcoins have greater growth potential, although they also carry considerable downside risk. Portfolio diversification allows you to take advantage of the growth potential of altcoins without taking on the risk entirely.
- Inflow of funds: one can lend virtual currencies and receive a percentage of your digital holdings. Alternative coins typically have generally high rates of interest than BTC (up to 20%). You can play the role of a bank and earn interest on cryptocurrency that you would’ve saved in your account in any case. You can redirect the income stream into other digital assets, broaden your portfolio, or utilize the funds to cover expenses.
Bitcoin has been a roller coaster ride for longer-term traders. The digital assets collapsed 80% in 2018 and recovered those losses in 2020. BTC rose from $1 to $30 in its early days before falling again to $5.
Those value swings can upset eager traders and encourage them to make ill-considered choices. Numerous traders have regretted that they sold holdings at inopportune moments and lost out on significant profits.
A portfolio that is diversified allows a longer time to await for the «lagging» asset to pull ahead. Diversifying your portfolio will encourage you to learn more about different assets and learn how to develop an investment strategy.
Top portfolio diversity strategies
Equity and bond investors have many diversification options. They look for the best companies based on market capitalization, revenue amounts, industry valuations, and other metrics. In the realm of traditional, more established financial holdings, more benchmarks exist to differentiate optimum investments from bad ones. However, cryptocurrencies have evolved and now have parameters based on which to diversify a portfolio.
Diversification by usage scenario
Many cryptocurrencies have use cases in the physical world: facilitating financial transactions, enabling smart contracts, etc.
Diversification by geography
Governments in many countries discourage cryptocurrency investors. In the US, some states are stricter on cryptocurrencies, while others have more flexible legislation. It is necessary to find out where cryptocurrencies are allowed and used. Digital assets in countries with favorable policies carry less risk compared to countries with stricter government oversight.
Diversification by blockchain criteria
Blockchains determine the number of transactions that can be made per second, the potential of a particular cryptocurrency, governance parameters and other key details.
Diversification by industry
Some cryptocurrencies are widely used in decentralized finance, while others are focused on different use cases (gaming, chain of custody, musical products and other industries).
Diversification by risk level
Any financial asset involves a certain degree of risk, and cryptocurrencies are inherently riskier. Less common altcoins with small market capitalization are more risky than Bitcoin and other popular digital assets.
Investors who are risk averse can place the majority of their funds in Bitcoins and in parallel open several small positions in different alternative coins. Traders prepared to take greater risk could choose to include mostly altcoins in their portfolios.
