Investment strategies, approaches, and principles differ from one market participant to another, but diversification is the one rule that all astute investors seem to abide by and for a good reason. Building a portfolio that includes a variety of assets from different classes and categories is the simplest and most effective way to manage risks. In case one asset doesn’t behave according to expectations, it won’t drag down the entire portfolio, as the rest of the holdings will ensure its resilience and continuity.
This seems like a perfectly reasonable and clever thing to do and is a strategy that includes all financial markets. Unfortunately, most investors only apply diversification across different asset categories like bonds, stocks, commodities, and crypto to reduce the likelihood of being impacted by sector-specific risks and maintain profitability in the long run. But fail to diversify within the same asset class – and crypto investments provide the most relevant example in this respect.
As the first crypto to hit the market and the top coin in terms of value and market capitalization, Bitcoin is the preferred digital asset for numerous investors. Traders and investors can buy Bitcoin p2p or through whatever channel they prefer and build their crypto holdings with ease. There’s nothing wrong with including BTC in an investment portfolio. On the contrary, Bitcoin can serve as a great diversification tool, considering its high return potential and innovative nature. The problem is that most people don’t look beyond Bitcoin when considering crypto investments, completely ignoring the fact that there are over 9,000 digital currencies from which one can choose.
An unfortunate Bitcoin-centric approach
The disproportionate media coverage that Bitcoin has received over the years has made it seem like none of the other altcoins matter. Many still think that Bitcoin and crypto are one and the same thing. Others still harbor the belief that the original coin is the only one worthy of their attention, as it represents the best product that this industry has to offer.
Ethereum is the only altcoin that manages to find its way into investors’ portfolios, most likely because the blockchain boasts unique features that have enabled a multitude of use cases across a range of different industries. However, not even the altcoin leader can come close to Bitcoin or make traders and investors acknowledge the need to distribute funds to more than just one crypto.
As a result, people continue to create crypto holdings where Bitcoin is exclusive. And while no one can deny that Bitcoin is indeed a strong asset to invest in given its proven track record in the industry. Creating a balanced portfolio by allocating funds to an assortment of digital assets remains the best way to go about crypto investing. So let’s see why one shouldn’t tie all their hopes to Bitcoin.
The importance of having a diverse crypto portfolio
Diversifying within the same asset class is something that is relevant to all types of financial instruments, but it’s even more important in crypto’s case because the market has certain particularities that one should take into account.
Although all markets present some degree of volatility, crypto’s unpredictability and constant price fluctuations far exceed that of traditional assets like cash, bonds, real estate, or precious metals. Despite the industry having matured in recent years, heightened volatility is still a constant in the crypto space. The price of a crypto coin can shift drastically in a matter of days or even hours, and there’s no way to predict these movements and trends.
This means that investors have the possibility to increase their earnings, but they are also exposed to a greater risk of experiencing considerable losses if they’re not prepared to navigate this unpredictable terrain. So, if you have all your crypto funds tied up in Bitcoin and the coin drops in value as it has numerous times in the past, your portfolio can take a heavy hit.
The most effective way to keep these risks in check and reduce the likelihood of major losses is in case Bitcoin takes a plunge. It is to make room in your portfolio for other digital currencies as well, and limit Bitcoin’s dominance and influence. Let’s imagine you distributed your crypto investments across Bitcoin, Ethereum, and several other altcoins, and none of these assets occupy a disproportionate share of your crypto holdings. If Bitcoin slumps by 50%, it’s highly unlikely Ethereum and the other digital currencies you hold will drop by 50%. They’ll probably perform differently and experience a slower decline or none at all, so they’ll be able to balance out the loss, and therefore, Bitcoin’s crash won’t have such a devastating effect on your portfolio.
Diversification strategies for crypto investments
There are different ways to go about diversifying your crypto investments, but the rule of thumb is to avoid holding too many assets that tend to move in the same direction. When searching for assets that don’t correlate to each other in terms of price movements, you can focus on the following aspects:
- Crypto classification – not all cryptos are created equal in that they have different characteristics and features. As a result, digital assets can be classified as stores of value, payment coins, stablecoins, DeFi tokens, privacy coins, and so on.
- Use cases – crypto coins also have different use cases across various industries, so looking into their applicability and how they can be used in real-world scenarios is also a great way to create a diverse crypto holding.
- Geography — digital assets reside in the virtual world, but they are influenced by industry-specific regulations that differ from one country to another. So you need to make sure you select coins based in different locations around the globe to avoid regulatory challenges.
- Time — you can also diversify by investing small amounts into various coins based on a fixed schedule. This will save you the trouble of checking price movements and chasing opportune moments to invest and earn a profit.
No matter your investment goals, crypto diversification is a strategy you should fully embrace to ensure a strong and healthy portfolio in the long run.
