Cryptocurrency Investment: Diversification Strategies

Don’t put all of your eggs in one basket! That’s common advice from both thoughtful grandmothers and expert traders. And there’s good reason for the advice.

Instead of relying on a single investment, the best investors find an array of high-quality opportunities. Much like eggs are only one of many important food groups, a single cryptocurrency is one of many coins within a healthy investment portfolio. So let’s explore how you can diversify your crypto portfolio.

Firstly, what actually is diversification?

Diversification is an investment strategy where you invest across different assets and investments so your portfolio isn’t fully exposed to any single risk or asset. Diversification in the world of crypto can lower your portfolio risks because different cryptocurrencies perform well at different times.

Financial experts might talk about Sharpe ratios, variance, and negative correlations, but at the end of the day, diversification boils down to not putting all of your eggs in one basket.

Maximise profits, minimise risks

According to Moneysmart, a financial information site from the Australian Securities and Investments Commission (ASIC), diversification lowers your portfolio’s risk and helps you get more stable returns.

When some assets fall in price, others may rise and balance out your portfolio. For example, in the first half of 2021 DeFi coins surged, while in the second half of the year metaverse coins were the major movers.

How to diversify your cryptocurrency investments in 5 simple steps

Diversifying your crypto portfolio requires you to invest across different crypto sectors, blockchain ecosystems, and coins.

1. Review your current crypto portfolio

What does your current crypto portfolio look like? Looking at your portfolio straight away will help you easily identify opportunities to diversify your portfolio.

A crypto portfolio could look like:

  • 50% Ethereum
  • 25% Polygon
  • 10% Aave
  • 5% MakerDAO
  • 5% Curve
  • 5% Uniswap

At first glance, the above portfolio looks well diversified. However, looking into the details, you realise they’re mostly from Ethereum DeFi. The exception is Polygon, which has close ties to the Ethereum community and runs an Ethereum Virtual Machine. Overall, the portfolio is susceptible to correlated risks based on its strong ties to Ethereum.

2. Compare it to the digital economy

Before you can identify the gaps in your portfolio and reallocate your investments, you need to make sure you have a good overview of the crypto space.

Crypto sectors

A diversified crypto portfolio will have a range of different coins from the main sectors. While the crypto space began with bitcoin as a single digital currency, it has blossomed into a vibrant ecosystem of decentralised platforms.

The overall crypto ecosystem can be broken down into:

  • Stores of value
  • Stablecoins
  • Smart contract platforms
  • DeFi
  • Oracles
  • Web3
  • NFT games
  • Metaverses

Blockchain ecosystems

Cryptocurrencies based on the same layer 1 blockchains often move similarly, rising and falling in price at roughly the same time. For example, the price of Uniswap and Curve, both built on the Ethereum blockchain, often rise and fall with Ethereum. If your investments are all based on a single ecosystem, such as BNB Chain or Cosmos, your portfolio is less diversified than a portfolio with tokens spread across different ecosystems.

Some of the most popular blockchain ecosystems are built on:

  • Ethereum
  • Solana
  • Cosmos
  • BNB Chain
  • Polkadot
  • Avalanche

3. Identify gaps in your portfolio

Now, take some time to compare your own portfolio with the overall digital economy. What sectors are you missing? Are you too heavily invested in a single blockchain ecosystem? What major coins are you missing? Make sure you note any gaps in your portfolio.

4. Reallocate your investments

Now you know what you’re missing, it’s time to reallocate your portfolio. This involves selling a portion of the coins that take up too much of your portfolio and buying some coins that you’re missing. For example, a trader that only held bitcoin might convert a portion to Ethereum, Solana, Cardano, Avalanche, Curve, and Decentraland.

5. Rebalance your portfolio periodically

Maintaining a diversified portfolio requires periodic reallocations. Over time, some of your cryptocurrencies will rise and others will fall. That means it’s easy for your portfolio to become underweight or overweight in a specific ecosystem or sector.

For example, if you held Axie Infinity at the start of 2021, it would likely have become a much larger part of your portfolio. All you need to do is convert some of the top performing coins to other sectors and ecosystems.

Choose the strategy that’s right for you

Diversification is one of the most popular investment strategies in the world. Not putting all of your eggs in one basket so you don’t break them all is reasonable advice. It’s been a successful investment strategy for millions.

On the other hand, you can’t make an omelette without breaking a few eggs and a concentrated portfolio can build wealth quickly. At the end of the day, you’re responsible for your own investments and should always do your own research, and make a decision that is right to your situation and financial goals.

Disclaimer: Information provided is for educational purposes and does not constitute financial product advice. You should obtain independent advice from an Australian financial services licensee before making any financial decisions.