How to Diversify Your Portfolio? - Reading time: about 3 minutes
Portfolio diversification can be a headache as it can demand substantial time for research and analysis, something many traders simply don't have or aren’t willing to commit. In the financial world, brokers and institutional investors understand this and develop products like mutual funds and ETFs to give retail traders diversity without the legwork.
This is the primary reason so many BTC advocates continue to hold their breath for a spot-based Bitcoin ETF as it would essentially provide a direct pathway to invest in BTC without having to deal with the custodial and transactional challenges for non-crypto natives.
The saying “don’t put all your eggs in one basket” may be a highly contrite one but is highly apt when building and diversifying your crypto portfolio. It’s essential to reiterate the importance of “risk appetite” when designing your crypto portfolio; you don’t want to lose sleep because your tokens are always top of mind.
As always, never risk more than you can lose.
The growth of the crypto space has led to the establishment of several blue chips that play a significant role in driving the market forward, so these will form the foundation of any portfolio.
In that case, why not just HODL Bitcoin and Ether?
Newer traders may be tempted to do just that, but bear in mind that If your portfolio consisted solely of BTC and ETH this could pose a major risk to your financial well-being due to the considerable correlation between the top 2 assets.
Correlation measures how closely a pair of markets tends to overlap, with a value of +1 reflecting a very high rate of correlation while a value of -1 denotes negative correlation, meaning the pair of markets move independently.
The correlation between BTC and ETH is currently at .85, meaning if Bitcoin suddenly corrects, ETH will likely see a similar plunge and your entire portfolio would be at immediate risk.
Diversify in Market Niches
One of the more full-proof methods of managing risk is through leveraging sector diversification. This disseminates your portfolio across the crypto space, reducing its volatility and managing risk.
Similar to how a stock portfolio should be balanced with blue-chip and non-blue chip shares, your crypto portfolio should be supplemented by an eclectic mix of cryptocurrencies in varying market sectors.
In all cases, the objective of asset allocation and portfolio diversification is to identify trading opportunities that are uncorrelated. A balanced portfolio can effectively weather the storm with the trader having essentially deployed capital in multiple sectors, increasing their ability to balance out losses with gains across the board.
In short, diversification manages risk through strategic and calculated exposure to markets with underlying potential while the blue chips serve to anchor your position.
Cryptoasset networks can be easily compartmentalized into several key categories dictated by the type of users they address. There are numerous more underlying sectors, each with their own rising competitors, but the main categories and examples below can potentially allow for an ample amount of asset diversification.
- L1 and L2 blockchain
- NFTs and the Metaverse
- Utility tokens