Experienced investors understand the purpose of diversification and how it helps to balance their investment portfolios. In traditional and crypto investing, depositing all funds in only one asset is risky and detrimental to portfolio health. If that one asset fails, all funds could be irreparably lost. The purpose of diversification is to ensure that the performance of one asset does not affect the overall strength of the portfolio.
The principle of diversification is essential in all financial markets, including cryptocurrency. Investing in a wide range of digital assets can protect your investment from loss and give your portfolio a better chance of growing its value. However, investors should note that this requires a considerable amount of research into the different types of cryptocurrencies, and how they can be split into multiple categories to increase the chance of turning a profit. To better protect your crypto investment, the following are a few strategies to consider:
Diversification by Longevity
The basic requirement for diversification is to hold multiple different assets. With adequate research, investors can learn enough to diversify their portfolios in numerous categories. For instance, you can consider keeping a percentage of your portfolio in established assets like Bitcoin (BTC), Ether (ETH), and Litecoin (LTC), cryptocurrencies that have stood the test of time and have maintained their positions as some of the largest assets in the market. In addition, you may consider new assets by participating in promising crypto presales for tokens that offer exciting utility to holders, including staking rewards of more than 300%, low transaction fees, and plenty of room for growth.
Diversification by Industry
Another way to diversify is to select tokens across multiple sectors. For example, you can buy a few tokens focused on decentralized finance (DeFi), especially as most agree that DeFi is very promising because it removes control from financial giants. With DeFi, anyone can transact, access much-needed funds, and expose themselves to financial leverage that is typically unavailable in the traditional market.
In addition to DeFi, metaverse and gaming tokens may be considered. Blockchain’s history is filled with successful games like Axie Infinity and Gods Unchained, which have helped players earn interesting returns via their play-to-earn (P2E) strategy. At its height, Axie Infinity helped indigent players to earn a comfortable living.
Diversification by Blockchain
Diversifying by blockchain requires spreading your investment across crypto assets on different blockchains. For instance, you may consider buying a few assets on Ethereum and a few others on Solana. This way, your portfolio is protected from blockchain-specific swings, where several assets related only by their underlying network may crash or spike.
Diversification by Risk Level
While nearly all decentralized cryptocurrencies are unstable, some assets may be more volatile than others. Meme coins – cryptocurrencies created as jokes or parodies of real events and launched without any real utility – are known to be more volatile than average. For instance, President Donald Trump’s meme coin, $TRUMP, successfully saw a market capitalization of $5.7 billion within a few hours and later hit $10 billion days after.
The best way to diversify by risk level is to begin with relatively stable options like BTC and ETH and gradually include more volatile assets. Generally, assets like BTC and ETH are unlikely to plunge in the short term and are more likely to recover even if they do.
Diversification by Geographical Location
While this is not the most popular diversification strategy, it can be very effective because of evolving crypto regulations. Diversifying by geographical location helps to protect a portfolio from changing rules if the government of an issuing company’s country suddenly outlaws crypto use, restricts the application or issuance of a particular asset, or changes its classification. By investing in assets from different regions worldwide, you protect your investments from unfavorable changes in regulation. When diversifying by geographical location, you may consider allocating a larger portion of your portfolio to assets from regions that have verifiable room for growth, development, and expansion.
Understanding Crypto Investment Risks
A basic knowledge of cryptocurrencies and blockchain technology is required to invest in crypto. This is the only way to properly manage a portfolio without avoidable exposure to risks typical of the crypto industry, including the following:
- Regulatory Updates: Governments and regulatory authorities worldwide are continuously modifying cryptocurrency laws. These new or altered regulations can affect the crypto market, causing prices to rise or fall significantly. The rules on crypto may also include classification, where one asset is classified as a security, changing how investors and even exchanges or trading platforms interact with the asset.
- Market Instability: The cryptocurrency market is notorious for its volatility and regularly records upward and downward price swings. These fluctuations can be positive when they result in gains, or negative when they cause heavy losses. Understanding the crypto market and the likelihood of price swings helps you manage your portfolio and may also help you make proactive moves to ensure portfolio stability.
- Technical Risks: Blockchain technology is known for its strong security, especially compared to traditional methods. However, the sector is somewhat prone to security breaches, technical failures, and several other errors that can compromise your portfolio. According to a Chainalysis report, funds stolen in 2024 increased by 21.07% to $2.2 billion year-over-year (YoY), with individual hacking occurrences rising from 282 to 303 in the same period.
Avoiding Diversification Mistakes
Diversification requires understanding crypto and paying close attention to the crypto market. The most important skill required is to always make educated and logical decisions. Investors who diversify sometimes suffer from fear of missing out (FOMO), which leads to emotional decisions such as buying an asset the market is excited about, even if the purchase does not align with their investment goals or diversification strategy. Investors should never allow market movements to affect a carefully planned curated strategy.
Also, investors must understand their individual risk levels. The amount of risk you can tolerate will largely shape your investment portfolio and how you diversify. For instance, if you cannot accept a lot of risks, allocating a significant portion of your portfolio to meme coins might be counterproductive because of their volatility. However, if you can tolerate risk and take the time to monitor the market, meme coins can provide great returns.
Other Strategies to Consider
HODLing: This is simply buying a cryptocurrency and holding it until the price increases. Hodling is a long-term strategy because investors have to wait out the increase without active trading or participation.
Day Trading: Experienced or professional investors can consider day trading, which involves buying and selling assets within one day while taking advantage of price fluctuations. However, this is only advised for knowledgeable traders who understand technical indicators like the Relative Strength Index (RSI) and Bollinger Bands and have time to analyze price movements.
Dollar-Cost Averaging (DCA): DCA is a simple strategy that provides some protection against market volatility. It involves regularly buying a fixed amount of a particular asset regardless of price or market condition. The advantage of DCA is that it lowers the average cost per coin of your portfolio and solidifies investment value.
Conclusion
All cryptocurrency investors must consider diversification as a non-optional part of investment. However, the specific strategy to use depends on several factors, including individual preference, risk tolerance, and the overall size of the portfolio. Either way, investors should understand the crypto industry and pay close attention to its workings before investing or diversifying.