Cryptocurrencies have exploded in popularity over the last few years. However, the crypto market is highly volatile and investing in just one or two coins can be incredibly risky. That’s why diversifying your crypto portfolio is critical for managing risk and maximizing returns over the long run. Here are some tips for successfully diversifying your investments across different cryptocurrencies.
Overview
Diversification simply means splitting your investments across multiple assets, rather than putting all your money into just one. This investment strategy aims to reduce the overall risk in your portfolio, since poor performance of one asset can be offset by better performance of others.
In crypto, diversification might involve investing in:
- Large cap coins (like Bitcoin and Ethereum)
- Smaller altcoins
- Utility tokens
- Security tokens
- Platforms like Ethereum as well as application specific protocols
- Coins focused on different use cases like payments, DeFi, storage, etc.
Spreading your capital across these different categories smooths out volatility and downside risk. It also allows you to capitalize on the upside from multiple sectors of the fast evolving crypto economy.
How to Diversify Your Crypto Portfolio
Determine an Appropriate Asset Allocation
As a starting point, decide what percentage of your total portfolio you want to allocate to crypto vs other assets like stocks or real estate. Financial advisors often recommend limiting crypto to 5% or less of your total portfolio.
Next, choose a distribution across different crypto assets. For example:
- Bitcoin – 40%
- Ethereum – 30%
- Smaller altcoins – 20%
- Stablecoins – 10%
Adjust these target allocations based on your risk tolerance and belief in each crypto’s potential.
Research Coins Thoroughly Before Investing
Don’t just invest in random coins hoping a few will do well. Thoroughly research each project first, assessing factors like:
- Technical credentials of the development team
- Roadmap and progress to date
- Current and target use cases
- Tokenomics
- Community support and network effects
This will allow you to create a diversified portfolio of projects you believe have real long term viability and investment merit.
Utilize Baskets and Indexes
Constructing and managing a portfolio of individual coins takes significant time and skill. An easier starting point is to invest in baskets or indexes that provide broad diversified crypto exposure, like:
- Bitwise 10 Crypto Index Fund
- Coinbase Index Fund
- Crypto20
These still carry considerable risk, however index approaches require less hands-on effort than picking specific altcoins.
Pros and Cons of Crypto Diversification
Pros
- Reduces risk from individual coin volatility
- Exposure to upside across multiple assets
- Less vulnerable to catastrophic losses
- Easy to achieve with index/basket approaches
Cons
- Returns may lag individual moonshot assets
- Still carries large systemic crypto risk
- Requires more research than just buying Bitcoin
- Rebalancing across many assets can be complicated
Tips for Diversification
- Use exchanges like Coinbase that support numerous crypto assets
- Keep some holdings in stablecoins to reduce volatility
- Set target allocation levels for different assets
- Rebalance your portfolio every quarter
- Don’t overcomplicate – in crypto, simpler is often better
Examples of Diversified Crypto Portfolios
Novice Conservative Portfolio
- Bitcoin: 50%
- Ethereum: 20%
- Coinbase Index Fund: 15%
- Stablecoins (USDC): 15%
Intermediate Growth Focused Portfolio
- Bitcoin: 30%
- Ethereum: 25%
- Solana: 10%
- Polkadot: 10%
- Uniswap: 5%
- Chainlink: 5%
- Cosmos: 5%
- Stablecoins: 10%
FAQs
Is crypto diversification really necessary?
Absolutely – concentrating all your capital on just one or two crypto assets can be an extremely risky approach. The crypto market is already highly volatile, so diversification across more assets helps reduce risk substantially. While returns may end up lower, risk-adjusted returns are often superior with diversified portfolios.
How many coins should I hold in my portfolio?
There’s no definitive answer, as it depends on factors like your total investable capital and risk tolerance. However most financial advisors suggest holding at least 6 to 12 cryptocurrencies. Just holding Bitcoin and Ethereum can be a reasonably diversified starting point.
What percentage of my crypto portfolio should be Bitcoin?
Typical allocation recommendations for Bitcoin range from 30% to 70%. Some even advise putting up to 90% of your crypto portfolio into Bitcoin, since it’s the least volatile and most proven crypto asset. But this provides little diversification. Given its potential upside and lower risk profile compared to altcoins, a 40-50% Bitcoin allocation is likely sound for most investors.
Is it better to invest in many cheap coins or fewer expensive coins?
Investing in many low value coins may seem attractive for upside potential. However, most these assets have extremely low liquidity and get hit hardest in bear markets. It’s generally safer to hold more valuable coins like Bitcoin and Ethereum that tend to weather market turmoil better. But combining a few mid to large cap coins with some small cap assets can an appropriate diversification strategy when done prudently.
How often should I rebalance my crypto portfolio?
There aren’t hard and fast rules, but checking your actual asset allocations against targets every quarter is reasonable. If market movements have skewed your portfolio significantly, taking some profits from high fliers and redeploying back into underperformers can restore balance. Avoid constant portfolio churn though – allowing winners time to win is key.
Conclusion
Diversifying across cryptocurrency assets, indexes, risk profiles, sectors, market caps, liquidity levels and regions is paramount to managing risk and maximizing long term crypto returns. Concentrating too heavily in Bitcoin provides little upside, while overly spreading across exotic altcoins can be disastrous when markets fall. Finding the right balance tailored to your goals and risk tolerance is key.