Here are some tips to diversify your cryptocurrency portfolio and protect yourself from the risk inherent in the crypto world.
Is it wise to diversify cryptocurrencies? Above all, can it be done? These are all legitimate questions, given the degree of risk that cryptocurrency trading poses to investors. However, the issue is more complicated than expected, since the asset is particular and could be subject to a different dynamic compared to fiat currencies.
In this article, we will discuss the diversification of cryptocurrency portfolios and offer concrete advice on how to diversify.
Why diversify your cryptocurrency portfolio?
The association between the concept of diversification and the world of cryptocurrency is far from obvious. However, at least at first glance, diversification is a smart choice, even when it comes to virtual currencies. That is why.
The main advantage of diversification. Actually, when it comes to investments (speculative or not), diversifying is always a good choice. The reason is simple: diversification, if done well, allows you to protect yourself from the risks inherent in a market. In particular, the risks caused by excessive volatility, external pressures that make prices and prices even more unpredictable. These risks, which in the world of monetary cryptography reach an extreme size, and can generate dramatic consequences for the operator. Therefore, the diversification of crypto-currencies can and should be done. The important thing is to know how to do it.
The question of correlations. In a cursory analysis, crypto-currencies may seem inadequate assets to meet diversification needs. The necessary condition for a diversification worthy of this name is the presence of a correlation, both negative and positive, among the assets. Now, from this point of view, virtual currencies seem to offer a few handles. On the other hand, it is Bitcoin that acts as a benchmark. However, if the market is analyzed in-depth, it is understood how the dynamics of correlations also involves world cryptography, although it is not direct and not immediately visible. Also from this criterion, therefore, it is necessary to start.
The cryptocurrencies are several. Another condition for carrying out good diversification is market heterogeneity. One characteristic, this one, which belongs to fiat currencies, since each of them refers to a certain economy. Also here, “seen from outside”, crypto-currencies do not seem to be suitable for diversification. And also, in this case, it is an illusion, an optical effect. On the contrary, the world of cryptography is quite heterogeneous, although the differences often concern technological infrastructure. Differentiation criteria will be discussed in the following paragraph.
The criteria for use
It is easy to say crypto money. In reality, this term refers to assets that are also very different from each other. First, the differences refer to the use for which virtual currencies have been designed or which, over time, have expired. From this point of view, there are at least three “variants”.
Reserve of value. Some cryptocurrencies are considered mere investment instruments or value reserves (in the periods in which they show some stability). This is the case of the most famous cryptocurrency, Bitcoin. It was conceived as the currency of the future, it is true, but over the years a radically different dimension has matured, that of the investment asset. On the other hand, an asset capable of growing 1000% in a few years, and of producing in extreme rallies, cannot be considered otherwise. Of course, it cannot act as a means of payment.
The forefront of infrastructure. Some cryptocurrencies are important not only for the role they play in investments but also for what they interpret in terms of value reserves. Rather, they represent a point of reference from a technological point of view, since they have a state-of-the-art infrastructure, which could serve as inspiration for the creation of networks or methodologies capable of showing off external use, which goes beyond The simple investments. This is the case of Ethereum, which has been the subject of many headlines precisely because of the technology that it carries. The same category includes NEO, EOS, Cardano and Tron.
Payment instrument Finally, here are the cryptocurrencies that the currencies are seriously so or at least approach. These cryptocurrencies are characterized by a higher than average stability and by their integration (total or partial) in the payment systems. This is the case of Bitcoin Cash, XRP, Stellar, Monero and Dash, but it must be said that the path to specific and widespread use as a means of payment is still long.
The dissemination criterion
Capitalization. It is perhaps the most important criterion, capable of determining a real hierarchy. The importance of this criterion comes from the dynamics that a well-capitalized cryptocurrency implies, compared to a low capitalized currency. The former, for example, are relatively protected from the risks of market failure, since any attempt to affect them in an unorthodox way is slowed down, or at least mitigated in their effects, by liquidity. At this time, as many know, the cryptocurrency with the highest capitalization is Bitcoin.
Investor community This is also a decisive criterion, also because it shows in a plastic way the degree of diffusion of a cryptocurrency. A very widespread asset, that is, that belongs to a large number of investors, expresses a certain solidity, which can have a correspondence both in the technical elements and in the technological factor. Also, in this case, the cryptocurrency with the largest number of investors is Bitcoin. On the other hand, it was the first to have a certain diffusion, and also serves as a reference point.
Developer Community This is a fundamental criterion to understand the ability of cryptocurrency to adapt to the standards required by the market, to put an end to the problems that may arise during normal exchanges. In general, the largest developer communities are those projects that are at the forefront of technology. From this point of view, Ethereum plays on an equal footing with Bitcoin, which on the other hand has gone through two forks (a symptom of a certain vitality of the developer community).
Potential. It is a criterion that is often ignored, but that can be very useful for diversification. Also because it provides clues about the future of cryptocurrency. In general, to analyze the potential it is necessary to compare the current state with the characteristics mentioned in the White Paper, provided that they refer precisely to the implementation. From this point of view, it is the most recent cryptocurrencies that have the greatest potential. In this case, Bitcoin yields.
Some tips to diversify cryptocurrencies
Diversifying the cryptocurrency portfolio is complicated. Also because it is the asset class in general that offers very special ideas, and still boasts a certain aura of mystery. In addition, it is quite rare to read qualified analyzes of crypto-currencies, perhaps by institutions of a certain weight. Therefore, merchants are forced to adopt a focus on all crafts, or at least customs, if they want to diversify with knowledge of the causes. Knowing the criteria of differentiation from the world of cryptography is certainly an important step to take, but it is not the only one. On the contrary, it is good to implement specific strategies, and that points to the maximum possible protection.
A useful tip is to give a preponderant weight to cryptocurrencies with greater capitalization. This may correspond, in terms of liquidity, to 50-60%. This means that the wallet is popular with Bitcoin and Ethereum for more than half of its weight. Bitcoin and Ethereum, in addition to being the most popular cryptocurrencies, are also the most liquid. The rest, that is, 40-50%, can be determined on the basis of the criteria mentioned in the previous paragraphs, perhaps assigning to each remaining crypto currency a weight equal to 5-10%.
Certainly, the kind of criteria that should be given more weight in the determination of the portfolio is linked to the uses. In fact, cryptocurrencies with different and well-characterized uses are those that escape the dynamics of the positive correlation, and that is freed from the benchmarking imposed by Bitcoin.
The main advice, however, is to act with the greatest caution and spend as much time as possible on the composition. It is good to repeat it: we are not facing any assets, so information and analysis are wasted. On the contrary, the world of cryptocurrency is an unexplored territory, which poses many difficulties. Without taking into account the changing context, caused, on the one hand, by technological progress and, on the other, by the evolution of the regulatory framework. Therefore, also prepare to adjust your shot, to modify your current portfolio. An awkward position, given the phase of uncertainty that this activity creates, but still mandatory if you want to maintain a sufficient degree of protection against risk. In short, prepare to study and test your intellectual energies.