Diversification is the key when investing in cryptocurrencies. Why should you do it? It is the key to minimizing risk. To spread uncertainty, you should buy (or sell if you’re a bear) across time and asset classes (bonds, commodities, precious metals, stock, crypto, fiat currencies, etc.).
In the world of cryptocurrencies, you can point to several segments where the price action in various scenarios should behave differently. For example, if you are a crypto bull at a particular moment, holding some stable coins would reduce your gains when Bitcoin, Ethereum, and others go up but will also limit your losses if the market goes against your intuition.
Here are some ideas on how you can diversify your cryptocurrency investments.
Majors vs Altcoins
Bitcoin and Ethereum are the two cryptocurrencies that rule the market and are the favorites to become the winner when their adoption spreads worldwide. However, this is far from certain. Maybe the future of finance is lurking somewhere among mid-tier cryptocurrencies, such as Cardano, Binance Coin, Polkadot, Doge, Chainlink, or Solana? Or perhaps even a smaller project, or the one that has not been introduced yet.
It’s challenging to multiply our assets just by holding BTC or ETH; they had their pioneering time a few years ago. The smaller projects should follow if they explode by 100% or 200% in the following years, the smaller projects should follow. On the other hand, they have been tested over time, and the probability of them going down to zero is relatively small.
That’s why you should mix the two classes depending on what you think about current crypto prices. Add smaller coins of your choice if you think we are around the bottom or ahead of a bullish run. If you think the near future of the crypto markets is less certain, add more BTC or ETH to your mix.
Stablecoins vs Others
Adopting stablecoins like Tether, USD Coin, Binance USD, or DAI proved very useful to cryptocurrency investors. Instead of just holding, they could cash out some of the profits if they thought the market was overheated and do it without exiting the crypto ecosystem and going back to fiat.
Holding some of the coins pegged to the dollar makes it easy to sell high and buy low, depending on your current opinion about the market. If the US dollar collapses, Bitcoin and others should benefit. If crypto enters a bear market, stablecoins can save you money. Meanwhile, you can use them for payments and decentralized finance like other more volatile coins.
Store of Value vs Payment Coins
If cryptocurrencies are to succeed, there are several paths they can take. On the one hand, they may become a better store of value than fiat currencies. Cryptocurrencies like Bitcoin have a deflationary nature. Their supply is capped, and with more people using it for more transactions, their importance should grow with time, unlike fiat currencies, where central banks print the supply to stimulate economies and keep the target inflation, which often gets out of hand.
Bitcoin can also work for payments with a second-layer solution like Lightning Network. At the same time, some cryptocurrencies like Bitcoin Cash, Litecoin, and others aim to facilitate microtransactions on-chain.
Proof of Work vs Proof of Stake
Bitcoin, Ethereum, Litecoin – the old cryptocurrencies run on Satoshi Nakamoto’s idea of proof of work (PoW) consensus. Currencies are extracted by miners giving their computation to the system and being rewarded for their job, and they run the system and get seigniorage privileges.
The problem with PoW is its small efficiency. Running the system is energy-consuming, and that’s why ETH spin-offs like Cardano or Polkadot run on a Proof-of-Stake. In this case, block transactions are not validated by miners but by cryptocurrency owners who stake a portion of their money to receive rewards.
PoS advocates argue this consensus system is safer and more economical, while PoW conservatives point out that a truly decentralized cryptocurrency system introduced by Bitcoin creators has no match. Time will tell who’s right.
These are examples of how you can divide the world of cryptos into classes of assets you can use to diversify your portfolio. Of course, you have your favorites and tokens you believe in, but the idea of diversification is about putting some of your money against your preferences 🙂
Apart from buying and selling cryptocurrencies over time, split them into different asset classes according to their risk. Stablecoins are relatively safe short term, as they are pegged to USD, but may blow out if the company or organization that runs them fails to follow the dollar. Bitcoin and Ethereum are definitely less risky than altcoins, but their future is not certain either.
New trendy projects can multiply your money in weeks, but you need to pick the one that succeeds. Do your own research and invest wisely. Remember that you can also hedge your long positions with smart leveraged shorts using a handy trading app, just like SimpleFX.