Strategies to diversify your cryptocurrency portfolio
Are you a bullish crypto investor whose entire portfolio consists of just one or a few coins? If so, you might seriously consider adding a little diversification into your crypto mix.
If you’re not entirely familiar with the concept of diversification, it’s the old wisdom of “not putting all your eggs in one basket.” Diversification means spreading your risk around, so that if some crypto assets fall in value, others may either decline to a lesser degree, maintain their value, or possibly even rise in value.
Key Points
- Investors can diversify a crypto portfolio by owning more than just digital tokens.
- Traditional and alternative assets can support crypto portfolio diversification.
- Diversifying your crypto portfolio can reduce risk and volatility.
The point is to avoid putting all of your money (and risk) into just a few coins or tokens. This can help reduce volatility in your portfolio and, hopefully, avoid a major crash.
Now, let’s take a step back. If you’re mainly a stock investor who’s interested in crypto exposure to diversify your stash of securities, then you can jump to our article on investing in cryptocurrency stocks. It talks about crypto but from a regulated (and less headachy) securities perspective.
But if you’re an advanced (or more dedicated) crypto investor who’s willing to dive into the rabbit hole of crypto complexity, then keep reading. We’ll cover four different ways to diversify your crypto investments.
1. Diversify across cryptocurrencies
A straightforward way to diversify your crypto portfolio is to add new tokens to your existing holdings. Deciding which new cryptocurrencies to add may present a challenge, but you can make that process easier by evaluating your current investments.
Where is your token portfolio currently lacking? Here are some ways to diversify if you have a burning desire to buy more cryptocurrency:
- Add large-cap or small-cap cryptocurrencies. If you own mostly Bitcoin, consider investing in emerging cryptocurrencies. If you own only small-caps, perhaps add Bitcoin or another large-cap token to your portfolio.
- Buy different types of tokens. Your portfolio can expand to include stablecoins, utility tokens, governance tokens, and other coin types.
- Diversify across sectors. A diversified crypto portfolio may include tokens that span industry sectors such as gaming, file storage, environmental protection, and finance.
- Expand across geographies. You can grow your crypto portfolio to include tokens that are primarily used within specific geographic regions.
- Invest in different blockchain protocols. A diversified crypto portfolio may include coins that use different consensus mechanisms such as proof-of-work and proof-of-stake.
- Support DeFi projects. Investors interested in the democratization of money may choose to own digital tokens associated with one or more decentralized finance projects.
- Invest in blockchain scaling solutions. Those aware of the challenges that can arise from crypto network congestion may be inspired to buy the digital tokens of a blockchain scaling solution.
Caveat: As with all major market crashes or bear markets, when the tide turns against the entire market, just about every asset class is vulnerable to a plunge. But if your portfolio is well diversified, it may fall to a lesser degree or recover faster than portfolios that are concentrated on assets that really fell out of favor in the markets.
2. Purchase tokenized assets
Investors can use blockchain technology to invest in tokenized assets, which represent partial or full ownership of a digital or physical asset. Those who invest in tokenized assets may receive non-fungible tokens (NFTs) representing their ownership stakes.
Many different types of assets—both tangible and intangible—can be tokenized, including:
- Real estate. Both physical and virtual real estate can be tokenized for fractional investment or outright purchase.
- Art. Digital art and fine art are both being tokenized for investors.
- Music. Tokenizing music is an emerging strategy that enables investors to benefit directly from an artist’s success.
- Collectibles. Vintage comic books, sports memorabilia, and other real and virtual collectibles are being tokenized by many digital platforms.
- Precious metals. Gold, silver, and other precious metals can be tokenized using a blockchain.
- Intellectual property. Investors in intellectual property can seek out innovative tokenization opportunities.
Caveat: Asset tokenization is still an emerging practice, so the market for some of these assets may be much less liquid (and more volatile) than others. Move cautiously if you plan on heading down this path.
3. Invest in an ICO
A risky option for crypto portfolio diversification is investing in an initial coin offering (ICO). A coin undergoing an ICO is—by definition—a new cryptocurrency that is not yet circulating on the open market.
Investing in an ICO is one way to add more “small-cap” assets to your crypto portfolio. Purchasing a coin in its nascency when the price is low can generate significant upside, but the coin’s value could also drop to zero. Be aware of the risks before diversifying your crypto portfolio with this strategy.
4. Crypto derivatives (for the advanced trader)
Just as the traditional financial markets support advanced types of securities—and the key theme here is “advanced”—the cryptocurrency sector has developed a range of derivative financial instruments. If you’re looking to diversify your digital asset portfolio, you might consider a few of these instruments.
But be forewarned. Depending on what you trade and how you trade it, you could expose yourself to significant risk, so consider the following only if you’re an advanced trader. Crypto derivatives include:
- Futures contracts. Cryptocurrency futures are agreements to buy or sell a specific amount of a cryptocurrency at a predetermined price on a future date.
- Options contracts. Crypto options grant either the right to buy or obligation to sell a cryptocurrency at a set price on or before a specific date.
- Perpetual swaps. This type of futures contract is available to crypto investors; it stands out because it lacks an expiration date.
Crypto investors can also access decentralized finance (DeFi) derivatives via several platforms. A derivative on a DeFi platform is based on an underlying DeFi asset and may be structured as an option, futures contract, or another advanced instrument.
How to make your crypto portfolio safer
Feeling bruised by the current price of Bitcoin? Another strategy to diversify your digital asset portfolio, and potentially lower its risk profile, is to focus on publicly traded cryptocurrency companies.
A broad range of businesses are partially or wholly dedicated to serving the cryptocurrency sector:
- Cryptocurrency mining companies produce new cryptocurrency.
- Crypto payment integrators enable users to purchase crypto with regular money.
- Hardware wallet manufacturers make physical cold-storage wallets.
- Digital asset custodians store your crypto.
- Digital asset insurance companies insure your crypto.
- Blockchain-as-a-service providers enable blockchain development to be outsourced.
You might also consider buying shares in a cryptocurrency fund. Exchange-traded funds (ETFs) with crypto or blockchain exposure are perhaps the most accessible investments for most investors. If you happen to be an accredited investor, you might consider hedge funds or crypto investment trusts.
Some of these crypto funds hold cryptocurrency directly, while others invest in assets that derive their value from a cryptocurrency’s price movements. Additionally, some funds invest in companies operating within the crypto industry.
The bottom line
Investing in cryptocurrency is risky—full stop. Cryptocurrency prices, as with the industry itself, are volatile. Plus, crypto scams abound (so, certainly watch out for those). As a crypto investor, you may not be able to entirely mitigate the risk. But you can creatively construct a well-diversified cryptocurrency portfolio capable of taking a few hard hits in the market.
This article is intended for educational purposes only and not as an endorsement of a particular financial strategy. Encyclopædia Britannica, Inc., does not provide legal, tax, or investment advice. Please consult your legal or tax advisor before proceeding.