Do you own a lot of Bitcoin? Or maybe your portfolio is weighted toward Ethereum, or another cryptocurrency.
Having an undiversified portfolio can be risky, but luckily crypto investors have many alternatives to diversify their holdings. Investors can choose to diversify within the crypto and blockchain sectors to broaden their exposure to this emerging asset class.
Keep scrolling to learn more about diversifying your crypto portfolio. Find out what your options are and the pros and cons of diversifying a portfolio of digital assets.
In this article:
- Ways to diversify crypto investments
- Pros and cons of diversifying
- How to diversify your crypto portfolio
Table of Contents
Video: 7 ways to diversify your crypto
What is crypto portfolio diversification?
The scope of crypto portfolio diversification is narrower than the scope of portfolio diversification generally, because diversification occurs only among different types of crypto assets. Investors can leave their overall portfolio exposure to the crypto market unchanged while still choosing to diversify their crypto investments.
Portfolio diversification isn’t a new concept—it’s a fundamental principle of investing.
See example below which visualizes two portfolios purchased in Aug 2021 and held for 1 year. The first is a portfolio of just Bitcoin, while the second is a portfolio diversified equally across Bitcoin, S&P 500, 10-Yr Treasury Bonds, a Commodities Index, and Real Estate.
The accumulated average returns show significantly less volatility in the diversified portfolio compared to the All Bitcoin portfolio, and ultimately a higher average return at the end of the period.
Diversification of your cryptocurrency investments is equally, if not more, important—its volatility makes investing in it especially risky. Managing and diversifying your crypto investment portfolio can be an effective way to reduce your crypto investment risk.
A diversified crypto and blockchain portfolio can benefit from the sector’s growth while potentially experiencing less price volatility. Investors can use diversification strategies to accomplish a myriad of investment goals, ranging from income generation to inflation hedging to capital appreciation.
Ways to diversify your cryptocurrency investments
In your crypto or blockchain portfolio, you can diversify across different coins, industries, and investments like physical real estate.
In a nutshell, you can diversify by:
- Industry focus
- Asset classes
- Investment vehicles
Diversify by coins and tokens
One of the most obvious ways to diversify your crypto portfolio is to diversify your direct ownership of digital coins.
Investors can choose from many types of crypto coins, including:
- Payment tokens: Cryptocurrencies like Bitcoin and Ethereum are well-known payment tokens. Payment tokens can be used to complete transactions wherever that cryptocurrency is accepted.
- Security tokens: Tokens that are backed by an underlying security, such as real estate. The tokens represent and convey ownership and are commonly fractionalized (or fungible tokens). HoneyBricks security tokens represent real ownership of high-quality commercial real estate.
- Utility tokens: Tokens that have a specific use case within a blockchain or crypto ecosystem are called utility tokens. Filecoin is an example of a utility token that facilitates decentralized data storage.
- Governance tokens: Tokens that enable users to participate in the governance of a blockchain are called governance tokens. Uniswap and Compound are examples of governance tokens.
- Basic attention tokens: Users can be paid for their attention, such as to digital advertising, using basic attention tokens. The best known basic attention token is affiliated with the Brave browser network.
- Gaming tokens: Investors can own coins that both have in-game value and are traded on third-party exchanges. Decentraland’s MANA is a prominent example of a blockchain-based gaming token.
- Non-fungible tokens (NFTs): Investors can own digital tokens that signify ownership of a specific asset. These types of tokens are “non-fungible” because the underlying assets are not interchangeable.
Diversify by industry focus
Another way to diversify your crypto or blockchain portfolio is to invest in cryptocurrency projects which are focus on different industries. Blockchain technology is being applied to—and disrupting—many sectors.
You can expand your crypto portfolio into industries such as:
- Healthcare: Blockchain technology can make the healthcare sector more efficient and secure. Investors can buy healthcare-focused cryptocurrencies like MediBloc and Dentacoin.
- Supply chain: Blockchain tech can make supply chains more transparent. VeChain is an example of a cryptocurrency designed for the supply chain industry.
- Transportation: Many aspects of the transportation sector can be innovated and improved using blockchain technology. Transportation-focused coins include Mass Vehicle Ledger and ParkinGo.
- Entertainment: Blockchain platforms can support a variety of entertainment options, and entertainment companies can integrate blockchain technology. Some entertainment coins include ApeCoin and Reef.
- Climate change: Blockchain tech can support initiatives to fight climate change. Climatecoin is an example of a digital currency that facilitates transparent investments into sustainability projects.
- Real estate: Investors can use blockchain technology to access fractionalized real estate investments. HoneyBricks supports a marketplace of blockchain-based real estate tokens.
- Private equity: An alternative asset class which is generally organized as limited partnerships, that buys and restructures companies. Some private equity funds have started tokenizing their fund to allow smoother buying and selling of the underlying shares in the fund.
Crypto market investors can also diversify across industries by investing in public companies that are pursuing blockchain projects. Using this strategy, investors’ options may be limited to publicly traded companies that are meaningfully pursuing a blockchain integration strategy.
Diversify by asset class
Crypto and blockchain investors have many options across asset classes to diversify their crypto portfolios.
These are other major asset classes that can provide portfolio diversification :
- Stocks: Investors can buy stocks of companies focused in the crypto sector, or stocks of companies with large cryptocurrency holdings on their balance sheets. Many crypto mining and hardware companies are publicly traded, while companies like Microstrategy have substantial crypto holdings.
- Bonds: Investors may be able to buy blockchain-based bonds that are digitally issued, or own bonds that invest in cryptocurrencies like Bitcoin. The World Bank, the European Investment Bank, the Singapore Exchange, and El Salvador have each issued blockchain-based or crypto bonds.
- Real estate: Investors can buy blockchain-based real estate tokens to gain exposure to the world’s largest asset class. Real estate tokenization platforms like HoneyBricks support fractional ownership of real estate through digital tokens.
Diversify by investment vehicle
If portfolio security is a perceived area of risk, investors can choose to diversify their crypto holdings across various investment vehicles and account types, including:
- Digital wallets: Investors can use different digital wallets to facilitate the direct ownership of digital coins, including special-purpose coins like NFTs and real estate tokens.
- Taxable brokerage account: Investors can hold crypto-focused securities investments in a taxable brokerage account. Brokerage platforms like Robinhood, which supports cryptocurrencies, can enable investors to also own digital assets in this account type.
- Cryptocurrency IRA: Crypto investors can establish self-directed individual retirement accounts (IRAs) to invest in digital assets. Crypto IRA platforms can assist investors with the administrative burdens traditionally associated with self-directed IRA investing.
- Decentralized financial products: Blockchain-based decentralized finance (DeFi) platforms can support a variety of ways to invest and hold digital assets. Investors can access decentralized savings accounts, staking platforms that produce interest income, and other blockchain-based investment vehicles.
Pros and cons of diversifying a cryptocurrency portfolio
A diversified portfolio of crypto assets has both benefits and drawbacks.
- Lower price volatility: Diversifying your crypto investments across sectors and asset classes can stabilize the overall value of your portfolio, especially during periods of market turbulence.
- Ability to rebalance crypto holdings: If one of your crypto investments performs particularly well, then you may find your portfolio to be overweight in one asset class or sector. Investors can rebalance their crypto portfolios in tandem with diversifying.
- Opportunity to learn more about the crypto economy: Diversifying a crypto portfolio provides the opportunity to learn more about many exciting projects and investment opportunities in the crypto sphere.
- Potentially lower absolute investment returns: Investing across asset types can provide greater portfolio stability, but may lower overall investment returns versus hitting a home-run on a speculative project that moons. Investing in a mix of cryptocurrencies and crypto-focused stocks, for example, may generate a lower yield than investing only in the riskiest cryptocurrencies with high volatility.
- Possible tax consequences: Selling or trading crypto assets to diversify a portfolio can generate a tax liability for investors in the current tax year.
- Requires investor research: Diversifying a crypto portfolio takes time, mainly in the form of conducting research. Investors need to devote sufficient time to develop a smart and customized diversification strategy.
Should you diversify your crypto assets?
A diversified portfolio can help crypto investors to minimize the overall price volatility of their holdings.
Depending on your investment strategy, diversifying a cryptocurrency portfolio can also produce some tax consequences. Investors who do their own homework are best equipped to pursue a portfolio diversification strategy—just make sure to allocate assets in a way that works for your specific investment objectives and risk tolerance.