Every investor wants maximum profits and minimum risks. One of the ways to do this is diversification, and this is especially relevant in cryptocurrencies, a particularly volatile avenue. A well-diversified portfolio consists of assets that tend to work differently.
How Diversification Helps in Crypto Investment
The digital assets market is very volatile; prices can suddenly shift in different directions numerous times a day to the advantage or detriment of investors. Therefore, just as volatility leads to an increase in profitability, it also multiplies the possibility of incurring losses. Diversification in portfolios helps balance such situations.
“Crypto does seem to offer diversification benefits in a multi-asset context. A small allocation of crypto to a portfolio of equities, IG (investment grade) and HY (high yield) credit, sovereigns and ‘traditional’ diversifiers like gold and energy enhances risk-return characteristics under various filtering criteria and time periods,” states a November 2021 report by HSBC Bank.
However, crypto fares poorly as a safe haven in a multi-asset context, the report adds. In fact, correlations with risk assets have risen in recent years. Despite the recent hype about crypto being a reliable hedge against rising inflation, there is little evidence of it when compared to market-based inflation expectations, the report states, adding that “there may be potential diversification benefits in a broader multi-asset context when considering crypto.”
Methods to Diversify Crypto Portfolio
There are various ways in which an investor can attempt to diversify his/her crypto investments. Here are three broad methods:
Through Industry
Make sure your investment is in a dynamic list of coins that provide viable solutions for a wide variety of industries. With this, you can reduce the unfavourable effect of industry-specific crypto-unfriendly regulations and events on your investment. Also, try to do research and invest in both solid and fast-growing businesses.
Through Geography
Diversify across regions. Don’t make all the investments in crypto projects in the same region or country. Plan thorough research on the performance of crypto projects in different parts of the world. Doing so will shield your investments from regulatory risk and give you an additional means of balancing out your diverse portfolio even in uncertain market circumstances.
Through Timing
Completely eliminating market risk is nearly impossible but you can be careful about when and where you invest. Diversifying investments by timing, also recognised as dollar-cost averaging, is an interval-based investment strategy. All you have to do is set aside planned amounts of money to invest in your chosen tokens at predetermined times.
“Crypto behaves like an extreme risk asset, not a safe haven. As such, small allocations can improve portfolio return/risk ratios – but these might diminish in coming years if crypto becomes more mainstream and correlations with traditional risk assets rise further,” states the HSBC Bank report.
Therefore, in terms of diversification, the rules that apply to other asset classes apply to cryptocurrencies as well.
