So you are asking yourself how to diversify your cryptocurrency portfolio?
Especially in the cryptocurrency space, where projects can disappear overnight, diversifying your cryptocurrency portfolio is a crucial component of an effective investment strategy.
This diversification needs to be executed carefully and backed by significant research in order to achieve the best results. In order to make this task easier for you, in this article, we will show you how to diversify your cryptocurrency portfolio like a pro.
As always, please keep in mind that this article does not constitute investment advice.
Why diversify a cryptocurrency portfolio?
Diversification is especially important in the cryptocurrency space because of its highly speculative and risky nature. While its true that diversification will likely not protect you from a broad market correction or bear market, it does minimize your exposure in the case that one of your holdings “exit scams”, does not honor the development roadmap, or is shut-down by regulators.
Furthermore, diversification in cryptocurrency can help you to grow your portfolio faster in a bull market. The right diversification will increase your exposure to several potential high-growth coins, or in other words, the more coins you hold the higher the probability of one of them doing a 50x.
When to diversify a cryptocurrency portfolio?
It probably makes little sense to diversify a 100 USD cryptocurrency portfolio. If you don’t have more than 500 USD available then it can be safe to stick to 2-3 coins you think have potential. Don’t dilute your capital by buying 40 USD stakes in many different coins in the hope of hitting gold on one or two of them. Not worth your time, and the fees you pay.
However, even if you only start with 100 USD but you invest them wisely, your stake might be worth a lot more in the future. If you had invested 100 USD in Ether in Summer 2016, your investment would be worth 2860 USD just one year later. If something similar happens to you, then that might be a great time to diversify the portfolio.
How to diversify a cryptocurrency portfolio?
There are several approaches when it comes down to diversifying a cryptocurrency portfolio. An interesting strategy is the following:
- The safe stake (60%)
- The moderately risky stake (30%)
- The gambling stake (10%)
A safe stake should be composed of major cryptocurrencies like Bitcoin and Ether. The goal is to have a core position in a few digital assets that are less likely to fail in the short-term, and that will still perform extremely well over a long period of time.
It’s important to note that what we call “safe stake” in this case is obviously not safe. However, relative to other cryptocurrencies, a clear upward trend and moderate stability can be observed in both candidates.
The moderately risky stake should be composed of a few medium-sized altcoins with active development, ideally the first version of a product, and at least half a year of track record.
A good rule of thumb is to be on the lookout for cryptocurrencies with a market capitalization between $100 and $500 Million that are listed at least on one major exchange. At the time of writing, some assets that would fit into this category are cryptocurrencies like EOS (EOS), Decred (DCR), Stellar (XLM), and BAT (BAT).
And finally, the gambling stake is focused exclusively on high risk and speculative tokens. These tokens or altcoins can be purchased in an ICO, or they can be micro-cap PoW altcoins.
It is very important to keep in mind that most of your coins in this allocation will likely fail in the long-term, however, if you do the right research you may end up holding one that brutally outperforms the rest of the market. This includes small PoW coins like Haven Protocol (XHV) or speculative platforms like Republic Protocol (REN).
It is also very important to constantly update your portfolio if the situation changes. What was a good investment one month ago, might not be a good one anymore. To properly rebalance your portfolio you should actively follow the communities of the coins you are invested in, and follow major cryptocurrency news sites and blogs.
Combining coin return models
Another interesting approach, especially if your portfolio is a bit more sizeable, is to combine coins with different return models. At the time of writing, there are 3 main return models in the crypto space:
- Passive holding coins
- Staking coins
- Dividend generating coins
In a Passive holding coin, the return is generated simply by holding the coin for the long-term and betting on a price increase. A prime example for this is Bitcoin, which price will go up as adoption for the protocol increases.
Staking coins require you to complete a task in order to earn an additional return. This task usually comes in the form of securing the network like in a Proof of Stake or Masternode system. An example of this coin type would be Dash, which enables anyone with at least 1,000 DASH to deploy a “Masternode” in order to earn more Dash by securing the network.
Finally, dividend-generating coins will earn you a monetary reward simply for holding the coin. These coins can be compared with the way dividend stocks work in the sense that a return is generated just by passively holding them. These coins are not very common yet since there is legal uncertainty about how such a reward model can work without violating securities laws in the United States. An example of this coin is DICE, which gives its owners a portion of the profits generated on the Etheroll gambling site.
Pascal Thellmann is an investor and marketer focused on the intersection of cryptocurrency and the legacy financial system. He co-founded Bounty0x, which at the time was the largest crypto freelance platform. Now Pascal dedicates his time to CoinDiligent and trading. You can get in touch with Pascal Thellmann on LinkedIn.