Diversification is a great way to significantly reduce the risk factor of any investment portfolio, delivering a much broader exposure to digital assets. This guide will give you all the tips you need to invest in the most risk-free way possible using diversification. Let’s get started.
Diversification is Key
If you’re looking for a balanced crypto portfolio, the key is diversification around your investments when you buy cryptocurrency. This gives investors the security of knowing they are hedging their bets against the volatile nature of the cryptocurrency market.
A common thing seen with new traders is the investment of only one currency. This single currency is usually one of the big-time players in the market, such as Bitcoin and Ethereum. While this could pay off if anything changed in the value of these coins and you only had singular assets, your entire capital would take a hit.
Spreading your portfolio across multiple assets is one of the most effective strategies to assist traders in managing potential losses and gains. By distributing any potential risks across various metaphorical egg baskets, a portfolio is much stronger. One that only consists of Bitcoin could have adverse effects when any Bitcoin news appears, while the balance can be gained through asset diversity.
Basics to Portfolio Balancing
The primary achievement in diversifying a portfolio to bring a balance is minimizing any impact that could be caused by a volatile market. Managing fluctuations is one of the key battles that come with trading digital currencies, and there are many investment strategies and approaches to manage this. To create a stronger portfolio better equipped to deal with a fluctuating market, you should invest in assets with no or very limited correlation across the market.
Poor diversification within a portfolio will contain two or fewer assets, such as Bitcoin and Ethereum, at an even 50/50 split. While the portfolio is spread across varying investments, it features coins with strong correlations. If you saw a major price fall in Bitcoin, the same would most likely be reflected in Ethereum markets.
To create a suitably balanced portfolio, the spread of investments is essential, not just between coins but between uncorrelated markets. Balancing your assets regularly is a good practice as it allows traders to manage losses during strong and bearish movements.
Portfolio Building Considerations
When building any portfolio, technical and fundamental analysis is required on all potential asset investments. Technical analysis is a great way to develop an insight into the potential future price movement compared to how it has moved in the past. Fundamental analysis is a little different as it helps identify strong uncorrelated assets to include in your portfolio.
Always identify the category when performing fundamental analysis along with the purpose and use of the currency you’re thinking about investing in. Though founded on blockchain technology, the crypto ecosystem consists of thousands of projects that cater to market segments or provide different uses.
Types of Currencies
As mentioned above, diversification of categories and currency is essential for a balanced portfolio. Payment-orientated coins such as Ripple, Dash, and Litecoin are highly correlated with Bitcoin, so you will see effects directly linked with any Bitcoin news. If your portfolio features varying coins such as DeFi tokens, privacy coins, security tokens, stablecoins, and utility tokens, it will follow an uncorrelated approach creating more balance. Here are a few examples of the main crypto categories available on the market.
DeFi tokens are used within applications to deliver a decentralized financial service such as crypto loans, liquidity pools, and staking. Examples of this style of crypto include Aave and Uniswap.
NFT coins are related to blockchain-based applications and protocols that support actual NFTs. Each NFT usually has its own native token, with popular examples including Axie Infinity (AXS), Enjin (ENJ), and Decentraland (MANA)
The purest form of cryptocurrency is the payment coin. These coins are usually used as an alternative to fiat currencies which can be used to pay for goods and services. The most popular coins for these services feature Bitcoin, Bitcoin Cash, Digibyte, Litecoin, and XRP.
You must complete your own research when investing in any kind of crypto market.