How to diversify your crypto portfolio: Risk management amid market volatility

Investing your spare cash into cryptocurrencies can be a lot of fun — and an incredibly lucrative hobby. That’s not always the case, however. Cryptocurrencies are incredibly volatile, so while it’s certainly possible to make a lot of money if you make the right investments at the right time, it’s also possible to suffer significant losses due to market volatility.

Many investors reduce the risk of large losses as much as possible by diversifying their crypto portfolio. In this AAG Academy guide, we’ll look at what diversification is, the benefits it can bring to any cryptocurrency investor, and how you can diversify your portfolio effectively.

What is a cryptocurrency portfolio?

A cryptocurrency portfolio is essentially a collection of cryptocurrency assets owned by one investor. You don’t really have a portfolio if you only invest in a single cryptocurrency, but if you put money into multiple coins, tokens, and other digital assets — such as NFTs — then you can say you have a portfolio. And that’s important if you want to be a sensible investor.

The term “portfolio” isn’t exclusive to the cryptocurrency industry. In fact, it has been used for decades within the wider investment world, where it is commonly used to describe a collection of different financial assets — which may include stocks, shares, bonds, mutual funds, and more — held by one investor. You’ve likely heard the term many times before.

Having a portfolio is critical if you’re looking to minimize your risk when you’re investing, but how you make up your portfolio is even more important. Owning different assets of the same class, such as stocks in multiple technology companies, can be a good idea. But owning different assets spread across different classes is even better.

How to diversify your crypto portfolio

This is what’s referred to as diversification, and though it can be a little more complicated when it comes to cryptocurrency investments — since all cryptocurrencies could be considered as one asset class — that doesn’t mean it’s impossible. There are actually a range of cryptocurrency coins and tokens you can invest in, as well as NFTs.

For instance, while Bitcoin (BTC) and Aave (AAVE) are both cryptocurrencies, one is used for payment and the other is classified as a governance token. Both exist within the same industry, but because they operate very differently, they are not considered to be comparable by cryptocurrency investors. Other types of cryptocurrency include:

• Utility tokens
• Security tokens
• Stablecoins

If you would like to learn more about these tokens, AAG Academy offers a great guide on the different types of cryptocurrency available today — as well as another dedicated to stablecoins. We highly recommend giving those a read if you’re new to cryptocurrency investing and you’re not familiar with the different kinds of token options out there.

In addition to investing in different types of tokens to diversify your portfolio, you may also be interested in spreading your spare cash across what would be considered market leaders in the cryptocurrency industry — such as Bitcoin, Ethereum, and other high-profile options — and smaller, newer cryptocurrency projects that may not have been around for very long.

Why is it important to have a diversified crypto portfolio?

Let’s say you’re a big believer in Bitcoin, so for one year, you invest all of your spare cash into BTC. During that time, you will experience all the market fluctuations you would expect to see if you’ve been following cryptocurrencies for some time; there will be times when your BTC sees considerable rises in value, and there will be times when it sees considerable falls.

Now, let’s imagine that you suddenly need all that spare cash you’ve been investing into BTC, but Bitcoin is currently in a period of sustained decline and your money is no longer worth anywhere near as much as it once was. If you have to cash out now and you cannot wait for Bitcoin’s value to rise again, you’re going to have to swallow a significant loss.

This is the risk you take when you do not have a diversified cryptocurrency portfolio. All your money is in one cryptocurrency, and because it is not doing so well, you’re losing out. But this problem could have been averted if you had instead invested your spare cash not only in multiple cryptocurrencies, but in various cryptocurrency types.

If you were to invest your spare cash not only in Bitcoin, but also in Ethereum and some stablecoins — and perhaps even into NFTs — you won’t suffer such a substantial hit when one or even two of those investments suffers a prolonged period of declines. And, if you’re lucky, you may find that when one is down, another is up, so they balance each other out.

Furthermore, diversification also gives you a better chance of earning a good return on your investment. The more cryptocurrencies you invest in, the greater your chances that one of your investments will experience a considerable rise in market value.

What is an example of crypto portfolio diversification?

As we mentioned above, diversifying a cryptocurrency portfolio isn’t quite as simple as diversifying a traditional investment portfolio because there are fewer asset classes to choose from, but it is possible. What’s more, it doesn’t have to be difficult. The first thing to think about is how risky you want to be when it comes to investing.

For instance, if you like to play it safe and you want to keep losses as low as possible, you may choose to invest 40% of your spare cash into more established cryptocurrencies like Bitcoin, 20% into altcoins, 20% into stablecoins, and 10% into NFTs. Assuming you aren’t going to be buying and selling often, you are less likely to see significant losses with this split.

If you are happy to take on a little more risk, you may choose to invest 30% of your spare cash into established cryptocurrencies, 30% into altcoins, 20% into stablecoins, and 20% into NFTs. It is likely a number of these investments will fluctuate more than others, so while you increase your risk of suffering a loss, you may also be more likely to see significant gains.

It is important to remember, however, that no matter how big or how diversified your cryptocurrency portfolio is, no one is completely immune to loss. Whenever you invest money into anything — whether it be cryptocurrencies or other financial assets — there is always a possibility that you will get back less than you originally put in.

References

• How to build a well balanced crypto portfolio
• Asset allocation and diversification explained
• How-to-building-a-well-balanced-crypto-portfolio