In the world of investments, where stability is a rarity, portfolio diversification is becoming not just a recommendation, but a necessity.
Diversification is distributing capital across different assets to reduce the impact of adverse events on one specific asset and the entire portfolio. Since the cryptocurrency market is subject to sharp price changes and high speculative risks, diversification is an important risk management tool.
Why is Diversification Important in Cryptocurrency?
The cryptocurrency market displays the following characteristics:
- High volatility. Prices of cryptocurrencies can fluctuate by tens of percent daily.
- Low predictability. News releases, changes to regulations, and the actions of major players all affect market behavior.
- Lack of fundamentals. Cryptocurrencies do not have any metrics, such as company profits, which can be assessed, like stocks do.
- Intra-market correlation. Many cryptocurrencies follow the dynamics of Bitcoin, which additionally increases the risk for the investor.
Basic Principles of Cryptocurrency Diversification
- Investing. Rather than putting all money into one cryptocurrency, investors spread their capital across three to five or more different crypto assets.
- Selecting different assets. Diversification involves investing in cryptocurrencies with different characteristics – different algorithms, market capitalization, etc.
- Risk management. Diversification reduces the risks associated with volatility and possible declines in the rate of individual cryptocurrencies.
- Multi-currency portfolio. In this way, the investor creates a diversified portfolio that includes various cryptocurrency assets.
Benefits of Diversification by Including New Assets
Reduced Risk
Deploying capital into various asset classes, including equities, bonds, real estate, and precious metals, allows you to diminish the influence of bad factors on your portfolio. When any one part of the economy is down, it will help reduce the investment drop in other areas.
The cryptocurrency market includes different asset categories, and it is important to consider them when diversifying:
- Bitcoin (BTC): With less volatility than alternative cryptocurrencies, it is the most steady.
- Ethereum (ETH): The second largest cryptocurrency by market capitalization with an extensive smart contract ecosystem.
- Altcoins: Smaller cryptocurrencies by capitalization, such as Solana, Polkadot, and Cardano.
- Stablecoins: Tokens minimize volatility by being linked to the value of fiat currencies, such as USDT or USDC.
- DeFi tokens: Assets of decentralized financial platforms (for example, Aave, Uniswap, Compound).
- NFTs and Metaverse Tokens: Speculative assets popular with investors in the digital art and virtual reality sectors.
Increased Return Potential
Including new and promising assets, such as technology startups or emerging markets, in your portfolio can lead to capital growth. Although such investments may be riskier, they offer the potential for high returns.
Accounting for Correlation
Correction determines how asset prices change. For example, Bitcoin and most altcoins often rise and fall together, which is known as high correlation. To reduce risks, add low-correlation assets to your portfolio: Bitcoin and stablecoins (low correlation), DeFi tokens, and central bank cryptocurrencies, stocks, or bonds outside the crypto market.
Global Diversification
Spreading investments across different countries and regions reduces dependence on the economic situation in one country. This protects against local economic crises and allows you to take advantage of growth in other parts of the world.
Explore and Use New Financial Instruments
Diversification allows investors to experiment with and employ new financial tools like cryptocurrencies and contracts for difference (CFDs). This provides access to new markets and ideas, contributing to higher total portfolio returns.
Cryptocurrency Portfolio Diversification Strategies
Proportional Strategy
This strategy allocates the portfolio based on the market capitalizations of the assets. For example, if the Ethereum market capitalization is equal to 30% of the overall market, an investor might invest 30% of their capital into Ethereum as one of the managed assets. This approach reduces divergence from the overall activity of the marketplace.
Equal Distribution
The funds are distributed evenly between the selected assets. For example, if there are ten cryptocurrencies in the portfolio, ten percent of the capital is allocated to each of them. This method is good for beginners because it reduces the risk of excessive concentration in one asset.
Risk-Based Allocation
The strategy divides assets according to their level of risk. For example:
- 50% of funds are in low-risk assets (Bitcoin, stablecoins).
- 30% in moderately risky (Ethereum, other altcoins).
- 20% in high-risk (new projects).
Dynamic control
Investors regularly review the portfolio based on market conditions. For example, when volatility increases, the share of stablecoins boosts, and when stability raises, riskier assets are added. This strategy requires active market monitoring.
Hands-on Recommendations
- Regularly rebalance your portfolio. Increasing or decreasing the amount of certain assets helps you keep the most advantageous risk-return balance.
- Use automated tools. Tools like Kubera, Zerion, Sharesight, and CoinMarketCap Portfolio help investors conveniently track their portfolios as they make changes.
- Follow the news and regulations. The crypto-assets market is highly subject to external events.
- Don’t invest any more money than you’re willing to lose. This is the main principle of acting in risky assets.
Conclusion
Diversifying a portfolio with new assets not only reduces risks but also helps investors adapt to the changing world of investments. Having an open mind to new instruments and markets, for example, cryptocurrency CFDs can give an investor an additional way to protect their holdings, while actively exploiting a new avenue to grow their capital. Finally, flexibility and readiness for change are key factors in a successful investment strategy.