Crypto Diversification Guide 2022: Why Should You Diversify Your Cryptocurrency Portfolio?
We know all people reading this are expecting a “You can’t put all your eggs in one basket” reference, and to their amusement, yes, that will be provided somewhere in this article (the question is, can you find it?). Now, coming to the nitty-gritty of what you can expect from this article apart from the egg-basket reference is the following:
- Why is cryptocurrency diversification necessary?
- What do we mean by diversifying cryptocurrency assets?
- Why is crypto diversification important?
Starting off with a bit of an introduction to the entire topic, a topic where we discuss diversification. Now to quote a good example of why diversification is necessary, we can very well look at the proverb quoted at the beginning of this article. The reason why generations have been advised not to put all of their eggs in one basket is solely for the purpose of teaching them how important diversification is. A father may teach his son not to depend on one person for his entire livelihood, or animal communities may learn to not depend on a single source of nutrition for too long and pass it down their generations via herd culture; no matter what example you find in nature for diversification, the point still remains crystal, diversification is found everywhere.
Now while looking at how integral diversification is in the biological sphere of human life may teach us only a lesson about the importance of diversification in the cryptocurrency world, the lesson is worth learning: Given how natural it is to ensure you have multiple sources from which you acquire something you need, it must be necessary. To reiterate, something as often occurring in our lives must only be occurring so commonly because it is necessary. That is what we want to explore first in this article:
Why is diversification necessary?
You drop the basket, you lose all the eggs. Assuming you are a person who wants to take as minimal risks as possible, the risk of you investing anything, from your time to your money, in just one asset is far greater than otherwise. Diversification is necessary, so in the unfortunate event where something unexpected rears its ugly head into the view, you’re only affected partially instead of wholly.
Let’s take an example to illustrate this point. Say you only had $50,000 to invest somewhere and what you end up doing is buying a car and putting it up on rent. Now you see where this venture of yours could go wrong? If that car meets any other passing vehicle with enough velocity, it shatters its hood, its windshield, and along with it, it shatters your dreams of making that $50,000 your next million.
What you could have rather done is diversify where you put those $50,000 in, so if you run out of luck in one place, a good portion of your money is still intact in other assets. This example just highlights one of the surface-level reasons why diversification, in general, is important.
Another reason to think about diversification is that it pushes you to look at multiple options and, more importantly, try each of those options as well. It forces you to learn more and experiment, which ends up with you learning more about the way things roll than you did previously. This is highly important in the cryptocurrency world where this article is concerned, and we will be talking about how it is so in the latter part of this article, but the fact that diversification is a way of doing things that leads to a much better version of yourself after having done it remains stand and strong.
Realistically looking at diversification, as stated earlier, forces you to try out multiple options as well, which makes sure you learn about an asset before you invest in it. More knowledge at the end, plus in a way you could say that you learn to take on risks that are new. In a way, your risk of losing all your money decreases while the number of risks you’re taking by investing in new assets increases. This allows you to develop a persona that is keen on minimizing risks you do not require and making sure you are not scared to take up risks that you are required to take.
So to come back to the question of why diversification is necessary, a one-phrase answer to this question could be “less unnecessary risk and a more knowledgeable you”. Now let’s look at how the art of diversification applies to cryptocurrency portfolios.
What do we mean by diversifying cryptocurrency assets?
Looking at how diversification comes under the context of investing in general or of cryptocurrency assets, to be more specific, allows us to really get into depth with how we can apply this strategy and gain the benefits mentioned earlier as well.
Diversification in terms of cryptocurrency assets means dividing varying percentages of your total investment into different assets. This means allocating your total investment amount to coins of different types and different performance rates. In cryptocurrency, we have a range of coins you can invest in. These include privacy coins, altcoins, and tokens. Researching over what each of these is is highly important before anyone invests in any of these, which is why diversification as a strategy was praised earlier in this article; it forces the investor to learn more.
The goal is to allocate your investment into different baskets in such a way that you reduce the risk of losing your investment the most and increase your chances of profits. When it comes to utilizing the advancements of cryptocurrency at hand that the current time has to offer, many overlook and go for what they think are the most famous approaches out there in the cryptocurrency sphere.
They think investing in just one coin, or the most famous one perhaps, which is Bitcoin, is enough. The approach stems from a lot of misconceptions or even misleading facts. Many go
for only investing in Bitcoin because they say Bitcoin since it is often always at the center of most cryptocurrency discussions and the leading coin in terms of popularity, sums up everything that the cryptocurrency market has to offer.
They believe that hence, it is enough to only have a sufficient amount of bitcoin in your portfolio and no other cryptocurrency asset. This is what you DO NOT mean by diversification. Rather it is the complete opposite.
As we have now looked at the opposite of what we are discussing, formulating an image of what is our prime focus will be easier. Diversification of Cryptocurrency assets will hence involve an investor choosing coins all different in performance and type.
They will choose not just the most famous, but a range of coins to ensure that if the most famous ones get botched down by media outcries for the sake of an example, then they may not lose all their investment capital since they had some of their money in other assets too. If they’re lucky, they may end up with more money than others and previously too. This is one of the benefits of Cryptocurrency Diversification which will be discussed later on.
Now moving on to creating diversified cryptocurrency portfolios, there are multiple ways in which this is carried out. One of the key factors investors consider when choosing coins to invest in is the price history of the coin, trends of the past, and how well it can do in the future.
Where there is a lot of choices, making a decision can be equally as difficult. With the current cryptocurrency market looking at around more than 5000 considerable coins, investors have a lot to choose from and amongst. One way to make diversification easy is by specifying the criteria you use to select assets in your portfolio. Let’s look at an example.
You can choose all the coins in your portfolio based on whether they are useful to society in a particular industry. This can be called diversification by industry, and at its core, the principle is the same as many leading businesses themselves; as long as it solves a problem, it’s valuable. Using this strategy, investors target coins that are vital in the industry, allowing them to be run efficiently and improving customer experience.
For instance, Elon Musk recently announced that its EV company Tesla would be accepting DogeCoin as a legitimate method of payment. This makes DogeCoin a means by which a process in the industry is being facilitated and hence, is a good coin to invest in. Other than the innovative electronics industry, globally competitive industries such as Medicine are also good choices.
Another way to pick up assets to invest in and further diversify your portfolio is by sorting them out on the basis of timing. By studying trends of your target coins, you can time your trading activity of any particular coin to your interest. Although the concept of ‘buying when it’s low, selling when it’s high’ is indeed an old one everybody is familiar with, it is still worth mentioning as a proper diversification strategy.
The aforementioned strategy is quite reliable and makes proper sense in every investor’s mind. However, it must be done right. Differing amounts of your investment capital must go into different cryptocurrencies for varying lengths of time. This means while you may buy and sell off a coin within 8 hours, you may still want to hold another of your investments for the next two months. Anything to do with time requires patience.
Among the many factors to consider when diversifying your cryptocurrency portfolio is where the coin is used in the world—in other words, sorting out which coins to use based on their geography. This could mean looking at which countries adopt which cryptocurrencies increasingly, either by policy or based on pure popularity among their populations.
An investor should hence target multiple countries of different regions around the world. They should diversify their portfolio, making sure that not all of their eggs are in one country or region. Leading regions to invest in are usually the United States, Europe, and Asia. However, one must make sure they are investing in multiple and not just a singular region.
One of the most popular and worst practices to do by many investors is simply compare the performances of two cryptocurrencies, say Bitcoin and Ethereum, without any context and use those findings to give trading advice to others. This is wrong. If you were to diversify your cryptocurrency portfolio based on the ‘context’ or ‘use’ method, you would start by looking at why a particular cryptocurrency was made in the first place. For example, Bitcoin was made as a completely virtual currency while Ethereum, on the other hand, is at the core of DeFi Protocols and smart contract technology.
By looking at coins this way, you will be more aware of what you are investing in. However, diversifying is where the art is at. Your portfolio should be investing in cryptocurrencies of multiple uses. So while 20% of your money lies in virtual currency, the rest is distributed equally in banking crypto, DeFi, and so on.
The other approach that owes a mention is the risk management approach. This is where an investor willingly decides to choose an amount to invest in relatively stable coins and a specific amount to put in highly-volatile risky coins. This is usually adopted when the investor has researched tremendously on all of his potential assets and believes they can use the swings in prices to extract a profit.
It should be noted, however, that stable coins are mere better alternatives to risky coins for the reason that their price remains relatively the same across time. Diversifying exactly using this strategy would require an investor to build their portfolio with proportions of stable and risky coins. It is the usual practice of many who make use of this strategy to invest a bigger proportion of their investment in stable coins, say 60%, while the rest of their investment could be cut in 30% to moderately risky options and the remaining 10% in high-risk assets.
This method allows the investor to test their skills and allow them a chance to use market volatility in their favor.
Now that we have browsed through a number of different methods via which you can sort out the assets you want to invest with diversification in let’s move to the next big question on the plate.
Why is diversification important?
As an expert in the market will tell you, you can never guarantee profits. No matter how solid the trader’s strategy, there is always a slim chance things may go sideways. Think of how shocked aviation investors would have been at the news of the coronavirus pandemic. Nobody could have predicted such a catastrophe, and guess what every single person who had aviation-associated assets thought at that moment; “I wish I had invested more outside of aviation” could be one way to phrase it.
This is why diversification is important. If one of your investments tanks, the others may still hold steady or even rise in value. However, let’s bring this discussion under the context of cryptocurrency again. One reason why diversification is necessary for cryptocurrency portfolios is to ensure if one of your coins or tokens falls in value, the other is still steady in value or rises. This is a risk-management associated benefit as if one coin’s value falls, and not all your money was in that coin, you still may have some of your investment still left.
This is a way to manage risks associated with cryptocurrency investing and is thus a common practice of many smart investors alike.
Another reason is more associated with high profits than low risk. The cryptocurrency market, when volatile, gives chances for high profits and high losses. It is the trader’s actions that ultimately decide how to exploit these chances successfully and thus decide how much of the available profit they take home. Having your investments which are put in non-correlated assets that are spread out in the cryptocurrency market ensures your chances of going broke, to be the least.
As it is advised to invest in differently performing coins, good places to look at in terms of investment would be coins essential to a decentralized financial system such as Bitcoin and Ethereum; however, this does not mean you only invest in that category. It is okay to allocate some of your investment amounts to risky coins as well. Do also note that your investment amount should be the amount you are willing to lose. This helps you learn about market trends and potentially make some profit in a safe manner.
Conclusion
To sum all of it up, the article was around the topic of diversifying your cryptocurrency assets. We dealt with the topic in three questions. The first question asked was “Why is diversification necessary?” and it was answered in a way any person, from a layman to a smart investor, could understand the many places we see diversification. After a brief introduction, we moved on to answering the second question that had to do specifically with cryptocurrency assets and their market and the different strategies people apply in order to carry out diversification of their crypto assets. The final question dealt with the importance of diversifying cryptocurrency assets, where we dealt with two major reasons why investors advise diversification specifically for cryptocurrency.
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