Liminal secures FSP license from FSRA in ADGM   Read more

Crypto portfolio diversification Explained

| November 17, 2023

Share this article

Cryptocurrency market traders utilize an array of tools to craft successful portfolio strategies geared towards long-term growth. Implementing effective diversification in cryptocurrency can serve as a valuable measure to alleviate both volatility and security risks. Nonetheless, it’s crucial to acknowledge that the absence of regulatory oversight can influence the valuation of digital assets held within the portfolio.

What is cryptocurrency portfolio? A cryptocurrency portfolio denotes a mixture of cryptocurrencies that an individual or institutional investor holds as an investment component within their broader portfolio. Its core aim is to strategically allocate various crypto assets to yield enhanced returns.

Why Diversify Your Crypto Portfolio?

Diversification is a strategic approach that involves allocating your investments across a range of different assets. Instead of concentrating all your capital in a single asset class like cryptocurrencies or gold, diversification entails dividing your investment percentages among various assets within your overall portfolio. This method serves to mitigate risk and reduce volatility, ultimately enhancing the stability of your portfolio. By diversifying, you prevent the possibility of catastrophic losses should one specific cryptocurrency investment, like Cardano, which you heavily bet on as an Ethereum rival, experience a sharp price decline.

Unlock the potential of digital assets for your institution

In simple terms, cryptocurrency diversified portfolio ensures that you don’t face the risk of losing everything at once in the event of a downturn in one particular investment. 

When it comes to diversifying your cryptocurrency holdings, the approach involves spreading your investment across multiple coins, tokens, or projects. Even investing solely in a single cryptocurrency, even if it’s a top-tier option like Bitcoin or Ethereum, carries its own risks. Both Bitcoin and Ethereum have witnessed significant price fluctuations over the past year, and such movements are likely to persist in the future.

For instance, in early 2021, Bitcoin’s price surged notably in conjunction with Coinbase’s public listing, fueling speculation about its imminent adoption by institutional investors. However, this optimism later shifted due to growing concerns about Bitcoin’s environmental impact and carbon footprint, with critics highlighting its relatively higher energy consumption compared to other cryptocurrencies.

Placing all your investments into a single asset stored in self-custody smart crypto wallet exposes you to the risk of substantial losses triggered by a singular event, such as a market crash, a cryptocurrency bear market, or even a seemingly minor occurrence like an unexpected crypto malware attack. By diversifying your investments across various coins and tokens including different sets of hot wallets and cold wallets, you reduce your vulnerability to the repercussions of negative news events or market downturns. This approach allows you to navigate through challenging periods and continue growing your portfolio.

Secure and manage your digital assets with Liminal

Most prominent use-cases in Web3 and their assets class

Web3, the decentralized internet, introduces a range of prominent applications, each associated with distinct asset classes: 

Decentralized Finance (DeFi): DeFi platforms use smart contracts to create financial services like lending, borrowing, and yield farming. Assets class includes cryptocurrencies like Ethereum (ETH) and DeFi tokens such as Compound (COMP). 

Non-Fungible Tokens (NFTs): NFTs represent ownership of unique digital assets, often used in art, gaming, and collectibles. They fall under the digital art and collectibles asset class – stored using hot/ cold polygon wallet.

Decentralized Autonomous Organizations (DAOs): DAOs employ blockchain governance for decision-making. DAO tokens stored using self-custody smart crypto wallet represent voting power and assets, such as governance tokens in the governance asset class. 

Blockchain Gaming: In-game assets and tokens within blockchain-based games are categorized under the gaming asset class, with cryptocurrencies like Axie Infinity (AXS) leading the way.

Decentralized Storage: Projects like Filecoin (FIL) offer decentralized file storage solutions, belonging to the storage asset class.

Web3 Infrastructure: Blockchain platforms like Ethereum (ETH) and Polkadot (DOT) are essential for Web3 infrastructure, forming the blockchain infrastructure asset class.

These use cases illustrate the diversity of assets and opportunities in the emerging Web3 ecosystem.

Types of Cryptocurrencies for Diversification

Diversifying one’s cryptocurrency investment portfolio involves exploring various types of cryptocurrency investments beyond the well-known Bitcoin and Ethereum. These options span several categories, including:

Altcoins: Alternative cryptocurrencies other than Bitcoin, like Litecoin (LTC) or Ripple (XRP), offer unique features and use cases.

Privacy Coins: Examples like Monero (XMR) and Zcash (ZEC) prioritize user privacy through advanced encryption.

Stablecoins: Pegged to stable assets like the US dollar, stablecoins like Tether (USDT) provide stability amidst crypto market volatility.

DeFi Tokens: Tokens powering defi integrations and access to decentralized finance platforms, such as Chainlink (LINK) and Aave (AAVE), enable various financial services.

NFTs: Non-fungible tokens, like CryptoPunks and NBA Top Shot, represent ownership of unique digital assets.

Utility Tokens: Tokens specific to particular blockchain ecosystems, like Binance Coin (BNB) for Binance Smart Chain.

Exploring these diverse cryptocurrency types in conjunction with Defi integrations allows investors to spread risk and seize opportunities across the evolving crypto landscape.

Different Strategies for cryptocurrency diversified portfolio

Within your crypto or blockchain portfolio, diversification can encompass a variety of elements, including different cryptocurrencies, industries, and even investments like physical real estate.

In essence, you can diversify in several ways:

Cryptocurrencies and Tokens: One of the most straightforward methods to diversify crypto portfolio is by expanding your holdings to include various digital coins and tokens. 

Here are some types of crypto assets you can consider:

Payment Tokens: These are well-known cryptocurrencies like Bitcoin and Ethereum, which can be used for transactions wherever they are accepted.

Security Tokens: Backed by underlying assets like real estate, security tokens represent ownership and are often fractionally owned. 

Utility Tokens: Tokens with specific use cases within blockchain or crypto ecosystems are called utility tokens. 

Governance Tokens: These tokens enable users to participate in the governance of a blockchain network. Notable examples include Uniswap and Compound.

Basic Attention Tokens: Users can earn tokens for their attention, especially in digital advertising contexts. The Brave browser network is associated with a well-known basic attention token.

Gaming Tokens: Investors can hold coins with in-game value that are also tradable on third-party exchanges. Decentraland’s MANA is a prominent example in the world of blockchain-based gaming.

Non-Fungible Tokens (NFTs): These digital tokens represent ownership of specific assets and are considered “non-fungible” because the underlying assets are unique and not interchangeable.

Diversification in cryptocurrency holdings across these categories can help you manage risk and potentially enhance your portfolio’s performance.

Another approach to diversify your crypto or blockchain portfolio is by investing in cryptocurrency projects that focus on different industries. Blockchain technology is actively reshaping numerous sectors, presenting opportunities for portfolio expansion.

You can broaden your crypto portfolio into various industries, including:

Healthcare: Blockchain technology enhances efficiency and security in healthcare. Investors can consider healthcare-focused cryptocurrencies like MediBloc and Dentacoin. 

Supply Chain: Blockchain improves transparency in supply chains. VeChain, for instance, is designed for the supply chain industry.

Transportation: Blockchain innovation can enhance multiple aspects of the transportation sector. Transportation-focused coins include Mass Vehicle Ledger and ParkinGo.

Entertainment: Blockchain platforms support a range of entertainment options, and entertainment companies can integrate blockchain technology. Some entertainment coins include ApeCoin and Reef.

Climate Change: Blockchain technology can bolster efforts to combat climate change. Climatecoin is an example of a digital currency facilitating transparent investments in sustainability projects.

Real Estate: Blockchain enables investors to access fractionalized real estate investments. HoneyBricks, for example, offers a marketplace for blockchain-based real estate tokens.

Private Equity: This alternative asset class, typically organized as limited partnerships, acquires and restructures companies. Some private equity funds have begun tokenizing their holdings to facilitate the buying and selling of underlying shares in the fund.

Moreover, crypto market investors can also diversify across industries by investing in public companies actively engaged in blockchain projects. This strategy may involve limited options, focusing on publicly traded companies genuinely pursuing blockchain integration strategies.

Diversification by asset class offers crypto and blockchain investors with hot wallets, cold wallets, and self-custody smart contract based wallets a multitude of options to broaden their cryptocurrency portfolios.

Here are some key asset classes that can be considered for portfolio diversification:

Stocks: Investors can purchase stocks of companies that operate within the crypto sector or companies holding significant cryptocurrency assets on their balance sheets. Numerous crypto mining and hardware companies are publicly traded, and examples include MicroStrategy, which holds substantial crypto assets.

Bonds: Investors may explore blockchain-based bonds that are digitally issued or bonds that invest in cryptocurrencies like Bitcoin. Notable entities such as the World Bank, the European Investment Bank, the Singapore Exchange, and even El Salvador have issued blockchain-based or crypto bonds.

Real Estate: Investors have the option to acquire blockchain-based real estate tokens, offering exposure to the world’s largest asset class. 

Diversifying across these asset classes can help crypto investors manage risk and create a well-rounded portfolio with exposure to various financial instruments.

Minimizing Risk in Diversified Crypto Portfolios

Feeling disheartened by the current Bitcoin price? Another effective approach to achieve cryptocurrency diversified portfolio, potentially reducing its risk profile, is to explore publicly traded cryptocurrency companies.

Within the cryptocurrency sector, a wide array of businesses operates, either partially or exclusively:

  1. Cryptocurrency mining companies engage in the production of new cryptocurrencies.
  2. Crypto payment integrators facilitate the acquisition of cryptocurrencies using traditional fiat money.
  3. Hardware wallet manufacturers produce physical cold-storage wallets for enhanced security.
  4. Digital asset custodians specialize in the secure storage of your cryptocurrency holdings.
  5. Digital asset insurance companies provide insurance coverage for your digital assets.
  6. Blockchain-as-a-service providers offer outsourced solutions for blockchain development.

You might also consider acquiring shares in cryptocurrency funds. Exchange-traded funds (ETFs) with exposure to crypto or blockchain assets are accessible to most investors. Accredited investors may explore hedge funds or cryptocurrency investment trusts.

These crypto funds vary in their approach: some hold cryptocurrencies directly, while others invest in assets whose value correlates with cryptocurrency price movements. Furthermore, certain cryptocurrency investment funds focus on companies operating within the cryptocurrency industry.

Monitoring and Adjusting Your Portfolio

When it comes to managing your cryptocurrency assets, adhering to a few straightforward principles can yield substantial benefits. Firstly, prioritize the construction of a well-balanced portfolio. The allure of cryptocurrencies might tempt you to allocate all your capital to a single asset or engage in excessive leverage trading. However, the initial step toward prudent cryptocurrency management involves crafting a diversified portfolio. Diversification in cryptocurrency serves as a means to disperse risk, reducing the likelihood of impulsive, emotion-driven decisions.

Secondly, achieving diversify cryptocurrency portfolio sphere can be challenging due to the tendency of many assets to move in tandem. A relevant strategy involves allocating a significant portion of your portfolio to established coins such as Bitcoin. While this approach may not result in meteoric gains, it also diminishes the risk of substantial losses, particularly in bearish market conditions. 

Lastly, stay vigilant in monitoring your investments. When your capital is distributed across various assets and platforms, keeping tabs on performance can be challenging. Leveraging cryptocurrency portfolio management tools can assist you in tracking your investments, facilitating necessary adjustments when required.

Conclusion

In summary, you can align your investment decisions with your objectives and risk tolerance by dedicating time to gain a deep understanding of each cryptocurrency, including its underlying concepts and future innovations. Mastery of this knowledge enables you to grasp the potential risks and rewards associated with cryptocurrency investments. It’s important to bear in mind that the digital currency market is marked by uncertainty and influenced by numerous factors. Diversification can serve as a valuable strategy to mitigate these risks and pave the path for potential success.

FAQ

Is it good to have a diverse crypto portfolio?

Maintaining an undiversified portfolio poses a significant risk that crypto investors should not overlook. Such a portfolio is heavily reliant on one or two tokens, leaving it vulnerable to crashes in their prices. This underscores the importance of implementing a stop-loss mechanism, which serves as a safeguard against adverse market movements.

What is a good crypto portfolio allocation?

According to experts, the 60/40 portfolio presents a well-balanced blend of the two leading cryptocurrencies, Bitcoin and Ethereum. It affords investors an opportunity to participate in the crypto market’s stability and growth potential. This allocation is typically favored by cautious investors who aim for consistent returns while also seeking exposure to assets with greater risk.

What is diversification in crypto trading? 

Diversifying your cryptocurrency portfolio entails distributing your investments across various coins, tokens, or projects. Even if you opt to invest in renowned cryptocurrencies like Bitcoin and Ethereum, putting all your resources into a single cryptocurrency investment can still pose risks.

Why is crypto portfolio diversification important?

Diversification stands as a fundamental principle in the realms of trading and investment, substantially reducing the risk associated with a portfolio. Through the strategic diversification of your cryptocurrency portfolio and the regular rebalancing of assets, you enhance your chances of safeguarding your holdings and realizing profitable returns.

How can one maximize diversification in their crypto portfolio?

Achieve Diversification in Your Cryptocurrency Portfolio: Spread Across Various Cryptocurrencies. Incorporate Both Large-Cap and Small-Cap Cryptocurrencies. Acquire Different Types of Tokens. Diversify Across Different Sectors. Expand Across Global Geographies. Invest in a Range of Blockchain Protocols. Show Support for DeFi (Decentralized Finance) Projects. Invest in Blockchain Scaling Solutions.

Are there any risks associated with crypto portfolio diversification?

Although diversifying a cryptocurrency portfolio offers numerous advantages, it can also present certain potential drawbacks. One such concern is the risk of over-diversification, where holding an excessive number of cryptocurrencies may lead to suboptimal returns.

More on Crypto

Liminal Custody received initial approval for a VASP license from Dubai’s VARA, paving the way for secure institutional custody services. Learn more. ……
May 27, 2024
As we move toward standardized and regulated usage of digital assets, it is remarkable to see more jurisdictions develop improvised versions of compliance with laws to help individuals and institutions stay safe and resilient. ……
May 23, 2024

Find out what is the Ideal Custody Solution for you