What Exactly is Portfolio Diversification in Cryptocurrency? Made Simple
Understanding the Mindset
The objective of every investor is to maximize profits and minimize risks. A very common and effective strategy to fulfil this objective is diversification of your portfolio by investing in a range of assets. The whole idea is to invest a varying percentage of your capital in multiple assets such that a plunge in prices does not excessively diminish your overall profitability.
Cryptocurrencies are one of the most volatile class of investments. Despite the current complexity of understanding the movements of the prices, the principle of "high risk, high rewards" holds in this asset class too.
This volatility can lead to increased profitability, but it can also multiply the possibility of incurring losses. Historically, it has been common for the price of a cryptocurrency to fall by a large percentage in a matter of days. In such cases, investors who have concentrated investments in that cryptocurrency would see large losses in their portfolio.
Is There a Solution?
To mitigate such levels of risk exposure, it is only financially smart to spread your funds across a range of crypto asset themes because a great man once said "Don't put all your eggs in one basket". In the long run, the combined performance of assets in a well-diversified portfolio may offset losses incurred by certain individual assets.
Many investors think Bitcoin consists of everything that cryptocurrency and blockchain technology has to offer. Thus, instead of adopting a crypto diversification strategy, they allocate all their capital to Bitcoin.
Although Bitcoin has recorded impressive returns over the years, nothing beats a balanced portfolio that takes advantage of the various technologies and utilities offered by blockchain. For example, investors that had diversified their crypto portfolios recorded greater gains compared to those holding concentrated amounts in Bitcoin during the DeFi boom of 2020.
The (Un)Explored World of Crypto
There are a variety of themes developing in the cryptocurrency market, with each theme offering its own unique promise. Here are some of the interesting themes in the crypto industry that you can look into for diversifying your portfolio.
Crypto asset themes:
Store of Value Assets – Other than offering the basic blockchain utilities such as frictionless and borderless transactions, these cryptos have acted as a store of value, providing great appreciation in value over longer time frames. The most popular one is ofcourse Bitcoin.
DeFi tokens – Defi platforms offer cryptocurrency trading on decentralised exchanges along with services like borrowing and lending. Passive income can be earned through staking and yield farming through Defi. Some of the popular Defi tokens are Aave, Compound and Uniswap.
Stablecoins – These tokens are backed by traditional currencies and have their values pegged to them. The biggest stablecoins are USD Tether or USDT, USDC and BUSD.
Metaverse – This theme consists of projects that have developed interactive virtual worlds. Users can buy digital land and freely build on top of it. They also offer things like customisable avatars, mini-games and live concerts among several other things. These worlds use their own tokens to run their virtual economies. The largest metaverse cryptos are MANA from Decentraland and SAND from Sandbox.
Smart-contract cryptos – Smart contracts are digital contracts stored on a blockchain that are automatically executed when predetermined terms and conditions are met. Ethereum is the biggest smart contract blockchain, with ETH as its native token. Other popular smart contract blockchains with their respective tokens are Cardano (ADA), Solana (SOL) and Avalanche (AVAX).
Gaming tokens – These games utilize the play-to-earn model. In this model, users can play and earn tokens or crypto while playing. This model has a very powerful psychological incentive, because it combines two activities that have driven humanity since the beginning of time: reward and entertainment. Top gaming crypto platforms are Axie Infinity (AXS), Enjin Coin (ENJ) and Gala (GALA).
Meme coins – This is the most ridiculous theme developing in the blockchain industry. A meme coin is a cryptocurrency that originates from an Internet meme or has some other humorous characteristic. Examples of popular meme coins are Doge coin (DOGE) and Shiba Inu (SHIB). Doge coin was created as a joke on the Doge meme by software engineers in 2013. This sparkled the creation of several subsequent meme coins.
The Main Question?
So, what next? With so many options to choose from, and with the high risk profile of each cryptocurrency, it can be a little tricky to find the perfect basket for yourself. If you are betting your money, then it is probably better you buy a lottery ticket. But if you are one of the serious ones, we have something that will change the way you invest in crypto.
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