Why is diversification essential for crypto investing?
I am sure that you have heard this quote thousands of times in your life but let me repeat it once again for you:
“Don’t put all your eggs in one basket.”
But have you followed this quote in your investment journey?
I am sure most of you haven’t, and thus let me explain this quote to you. The logic behind it is simple: “If you put all your eggs in a single basket, what will happen if you drop the basket?”
No More Eggs 😥
But consider the contrast of it: “You have a collection of baskets and a few eggs in each of them, now if you drop one basket, you will only lose a few eggs, but you will still have plenty more eggs left in the remaining baskets”.
The same is the philosophy with portfolio diversification because if you will invest in a single asset by being too bullish and if, due to some reason market goes down, leading your assert to crash, then you will end up hitting your entire portfolio very badly.
But in contrast to that: If you will invest in multiple asserts and now if the market crashes, then there is a high chance that only a few of your assets will crash, while a few others will remain stable, and maybe one of them will rise exponentially. In this case, it didn’t damage your portfolio that hard and provided you with the cushion against the sudden fall in the market.
Why is everyone talking about diversification now?
The cryptocurrency market has faced many red and black days in the previous few months, which has led to the shift of investors from just investing in a single crypto asset to diversifying their portfolio, which will help them minimize the risk and maximize the profits.
Many new investors who had entered the space just a few months back have also faced significant losses due to the sudden breakdown; thus, what I would like to recommend you is if you are already an investor and not using the magic of diversification, then it’s the right time to start it.
But if you are new to this world of crypto investing, I would like you to recommend the below article in which I have explained the positive and negative sides of investing in cryptocurrency very clearly and answered the most asked question in the market. “Should you invest in cryptocurrency?”.
https://medium.com/edviconedu/should-you-invest-in-cryptocurrency-f94fcdbf7a6f
Ways to diversify your crypto portfolio
There are numerous ways to diversify your crypto portfolio, but in this article, we will cover a few of the best techniques/ways to get higher returns with minimum risk.
You can also use 1 or more ways to diversify your portfolio in order to make it a truly diversified portfolio.
- Diversification by Crypto Classification
Because of its basic approach, this is the most common diversification strategy. The idea here is to invest in various high-performing cryptocurrencies as different cryptocurrencies have different underlying technology and foundation that powers them.
Some of the famous types of cryptocurrencies are:
A. Store of Value: Bitcoin
B. Smart Contract Cryptocurrencies: Ethereum and Binance Coin
C. Payment Coin: Litecoin and Bitcoin Cash
D. Stable Coin: USDT, USDC and Dai
E. Defi Tokens: Aave and Compound
F. Privacy Coin: Monero and Dash
G. Non-Fungible Tokens (NFT): Decentraland and Chiliz
……
Note: Above are just examples of each type of cryptocurrencies and not investment advice.
2. Diversification by Market Cap
Market cap in itself speaks a lot about the investors’ demand, belief, and faith in that particular crypto. This basically means that investing in crypto’s that belong in the list of Top 500 or Top 100 or Top 50 … will give you a kind of assurance that these are crypto’s that can be trusted as they are time tested and also do have the potential to grow even more in future.
Market Cap = Total number of units * Current price of 1 unit
3. Industry Diversification
As the number of crypto projects are increasing day by day, you need to make sure that your portfolio includes those which have viable use case/solutions for a wide variety of industries. The aim benefit of this approach is that it will reduce the unfavourable effect of industry-specific crypto’s.
It is similar to investing in stocks from different sectors to protect your portfolio from getting hit by the fall of a particular industry.
Some of the prominent industries with crypto projects include:
Finance
Data and analytics
Medicine
Supply Chain Management
Energy
….
4. Geographic Diversification
This is one of the least common ways of diversifying your crypto portfolio. But many times, a big saviour too. Many experts have advised that you shouldn’t invest in crypto projects in the same region or country.
And they highlight 2 main reasons for the same:
A. Regulatory Risks
B. Uncertain market circumstances
This basically means that by not investing in crypto projects in the same region, your portfolio will be shielded by regulatory risks. In addition to that, it will also be balanced to face any uncertain market situations.
5. Time Diversification
I know it is almost impossible to time the market, and obviously, this practice can be too costly at times, but there is one other way around for this.
All you need to do is set aside some predetermined amount of money to invest in your favourite tokens at times when the market falls by some significant percentage, or what you can do is buy in small chunks whenever you feel that market seems cheap now. This is famously known as “Buying The Dip”. By this way, you will end up lowering your average buying price of the token resulting in greater profits when the market booms.
Dollar-Cost Averaging (DCA) is also a well-known technique under time diversification, but the main issue with DCA is that it has more downsides than “Buying The Dip”.
DCA works almost in the same manner as SIP (Systematic Investment Plan), in which you will invest some predetermined amount every month. Thus, the main disadvantage arises when the market is in the bull run, but it has advantages similar to “Buying The Dip” in the bear run.
In both techniques, you will end up lowering your average buying price of the token during the bear run resulting in greater profits when the market gets back on track.
My experience with diversified portfolio
I have been into crypto investing from the past 7 months, and before that, I was into stocks, mutual funds, … and other investment assets; thus, from day one I had used the magic of diversification.
There is no doubt about how well it can protect your entire portfolio from a big disaster or maybe save you from bankruptcy if you had invested all of your savings.
My initial 3–4 months were like a honeymoon period in which I enjoyed good returns, and my portfolio was increasing every single second (This is what happens in a bull market). But soon after that, things started going wrong as various countries started discussing about banning crypto trading, and a few of them stopped crypto mining and what not.
Thus starting from Bitcoin to Shiba Inu, all those who were in my portfolio and the ones who weren’t starting going down just like a free fall. And if I describe the worst-case conditions in which few coins were 🔻80% and in the best case about 🔻40%-45%.
But my life saviour diversification decision saved me as in the worst case my portfolio was 🔻40%, and in the best case, it’s about 🔻20%. Thus I had the mixture that gave me a good cushion over the situations in which many investors either ended with 0 or a significant loss.
Conclusion:
The real benefit of diversification is to limit the extreme outcomes. Owning 10 coins instead of one improves your odds of getting a ride to the moon, but it may eliminate your chances of getting a ride to pluto.
Ending Notes
I hope you have enjoyed the article and learned something new that will surely make a good impact on your life. I would be delighted if you could spare a moment for a clap, and your valuable comment will be a cherry on top of the cake.
You can find me on LinkedIn, and I am also open for discussion on Email.
I will miss you as the most precious reader until the next article comes out. Signing Off “With Love Umang Thakkar”.
