Risk is unavoidable when investing — but that doesn’t mean it can’t be managed. Here’s what you need to know about how to build a diversified cryptocurrency portfolio.
Generating profit, over either the short term or long term, is the primary goal of any cryptocurrency investment. When creating a crypto portfolio for investment or trading purposes, however, it’s impossible to avoid risk entirely. The cryptocurrency market is inherently volatile and often forces investors and traders to take on more risk than is tolerable.
Creating a well-balanced crypto portfolio by diversifying the assets you invest in can significantly reduce your exposure to risk while increasing exposure to a broader range of digital assets than a highly correlated portfolio.
What does a well-balanced, diversified cryptocurrency portfolio look like, though, and how does crypto portfolio diversification work?
Diversification is Key
Building a balanced crypto portfolio means diversifying your investment portfolio. Diversification provides investors and traders with a powerful way to hedge against the volatile nature of the cryptocurrency market and assists with risk mitigation.
Many new cryptocurrency investors and traders choose to invest only in major cryptocurrencies with high market capitalization such as Bitcoin or Ethereum. The crypto market does follow the price action of Bitcoin to a certain extent — bullish Bitcoin price movements, for example, are typically reflected across most other crypto assets and altcoins. This doesn’t mean it’s best to only invest in Bitcoin, however.
Spreading your crypto portfolio across multiple assets is an effective strategy that can assist traders in managing potential gains and losses, distributing potential risks. A portfolio consisting only of Bitcoin may be adversely affected by bearish Bitcoin news, while a well-balanced portfolio may balance Bitcoin losses with other assets.
Portfolio Balancing Basics
The primary goal of building a balanced and well-diversified portfolio is to minimize the impact of the volatile market by managing risk and adopting a variety of different investment approaches or strategies. Investing in a group of assets that provide exposure to a broad spectrum of uncorrelated areas or markets provides traders with reduced risk and a significantly more robust portfolio.
A poorly diversified crypto portfolio may consist of just two assets — Bitcoin and Ethereum — at a 50/50 distribution. While this portfolio spreads an investment across multiple cryptocurrencies, both assets within this portfolio are highly correlated. A major price drop in the value of Bitcoin is likely to be reflected in Ethereum markets.
Creating a suitable portfolio means spreading an investment across multiple uncorrelated assets and balancing your asset allocation regularly. This allows traders and investors to manage losses during bearish market movements.
What To Consider When Building a Portfolio
When building a balanced crypto portfolio, it’s important to perform both fundamental and technical analysis on the assets you’re considering investing in. Technical analysis can provide insight into potential future price movements of an asset, based on previous price movements. Fundamental analysis, however, can assist with identifying uncorrelated assets to include in your portfolio.
When performing fundamental analysis on an asset you’re considering including in your portfolio, it’s important to identify the category, purpose, or use case of the crypto asset you’re investing in. The crypto ecosystem, while founded on blockchain technology, is comprised of hundreds of different projects that all provide different use cases or target different markets.
Types of cryptocurrencies
A portfolio consisting of only payment-oriented coins, such as DASH, Litecoin, Ripple, is highly correlated. A portfolio that consists of a combination of different coins including payment coins, stablecoins, governance tokens, security tokens, utility tokens and DeFi tokens, however, is highly uncorrelated. Below we have provided examples of different types of crypto categories:
Payment coins are considered to be the purest form of cryptocurrency. They are typically used as an alternative to fiat currencies to pay for goods and services. Popular payment coins include Bitcoin, Litecoin, Digibyte, Bitcoin Cash and XRP.
Smart contract platforms
Stablecoins are blockchain-based currencies that are pegged to real-world assets likes fiat currencies (e.g. US dollar) and commodities (e.g. gold). Examples include USD Tether, USDC and PAX Gold.
DeFi tokens are used within applications that provide decentralised finance services like crypto loans, staking and liquidity pools. Examples include Aave and Uniswap.
Privacy coins are crypto coins and tokens designed to offer privacy and anonymity to their users. Examples include Monero (XMR) and Zcash (ZEC).
NFT coins refer to blockchain-based protocols and applications that support NFT’s and have their own native tokens. Popular examples include Axie Infinity (AXS), Decentralan (MANA), Enjin (ENJ) and Theta.
It’s extremely important to do your own research when investing in cryptocurrencies. You can read our guide on different cryptocurrency categories to learn more about the different crypto-assets and their use cases.
Fundamental analysis factors to consider
In addition to measuring the correlation between assets in a diversified portfolio, it’s essential to perform due diligence. Effective due diligence assesses a variety of factors, which can include:
- Use cases, or the purpose of a coin. Consider the utility of a coin, what kind of problems it solves, and how likely it is to be adopted in favour of legacy solutions
- Technical advantages or obstacles can play an important role in the success of an asset. Crypto projects that provides a compelling solution to the scalability problem with high transaction speeds, for example, may present a compelling investment opportunity
- Market capitalization can impact the volatility of an asset — “small-cap” cryptocurrencies are typically more volatile than cryptocurrencies with higher market cap
Keep Up With Industry News
The crypto market is a fast-moving ecosystem that is significantly affected by major news announcements, project updates, and new information. It’s important to note that the top 50 cryptocurrencies by market cap were all, in their earlier stages, new projects with little to no media or community interest.
Remaining updated on the latest news within the cryptocurrency sector can provide investors and traders with insights into potential investment opportunities or upcoming roadmap milestones for major projects that can have an impact on price trends.
Charting tools such as TradingView provide traders and investors with customizable updates and news feeds on tracked assets, allowing users to capture up-to-date information on promising projects.
Coindesk is a reliable resource for crypto news and updates.
Track Your Portfolio
Tracking your portfolio is critical when maintaining a balanced and diversified cryptocurrency investment portfolio. There are numerous reputable crypto portfolio trackers available. Swyftx provides users with a real-time profit/loss status across all holdings through a robust portfolio tracker that can be accessed via the navigation panel on your Swyftx account.
Learning how to track and, if necessary, rebalance your crypto portfolio is a highly effective investment strategy. The information provided via Swyftx’s portfolio tracking features allows users to stay updated on price movements, performance, and cap.