Why crypto investors also need to diversify

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Mark Farfan treats crypto as a mixture of investing and gambling.

He’s a long-term starter who only puts in what he’s comfortable losing. While the bulk of Farfan’s crypto wallet – 80% – is made up of coins that he believes are there for the long haul, like Bitcoin and Ethereum, he has also diversified into smaller coins like Cardano, Litecoin and Stellar. The 30-year-old from Ottawa says the more coins he bets, the more likely he is to bet on one that takes off.

“I’m not going to pretend I’m a crypto genius,” Farfan says. “It’s pure luck.”

If you follow the basic rules of long-term investing – rebalancing regularly to have a diversified portfolio – you’re probably familiar with the idea that you don’t want to invest too heavily in an asset or security. And if we assume that we don’t want to put all of our eggs in one basket, then it makes sense to diversify your crypto investment into more than one token, says Anjali Jariwala, founder of FIT Advisors.

But “diversifying” a crypto portfolio is a lot different from diversifying a portfolio of stocks and bonds. Here’s how it can – and can’t – help you.

The advantages of crypto diversification

Diversification has traditionally had two benefits: It provides your portfolio with “uncorrelated” assets so that as some investments accumulate others hold up or even increase in value, and it protects you (ideally) from a loss. catastrophic if one of your investments implodes.

The first advantage comes into play only weakly with cryptography. A traditional investment portfolio benefits from the fact that bonds tend to rise in value when stocks fall, helping investors weather bear markets. In contrast, cryptocurrencies tend to rise and fall together.

The real benefit of diversifying into cryptocurrency is that it limits extreme outcomes. If one cryptocurrency fails and your investment goes down to zero, other crypto investments may still perform well, Jariwala says. Ideally, your entire crypto wallet will not be wiped out because of a single coin.

Of course, diversification could potentially limit your earnings. But, look at it that way. Having 10 coins instead of one improves your chances of getting to the moon, though, perhaps, it eliminates your chances of getting to Pluto.

Investing in smaller projects and coins whose functionality is at the heart of the decentralized finance (DeFi) ecosystem in general is also a good way to profit from the future of cryptocurrency, says Anastasiya Belyaeva, manager. growth at PieDAO, a platform that offers investors a range of crypto wallets.

DeFi refers to a form of financing that does not depend on third parties like banks or governments. But this lack of regulation also carries risks. According to a report from CipherTrace, a crypto intelligence firm, DeFi-related losses from crimes like hacking and fraud reached an all-time high in the first seven months of 2021.

Limits of crypto diversification

A big problem with the diversification argument, however, is that all digital coins are correlated. When Elon Musk tweeted that Tesla would no longer accept Bitcoin, for example, the price of tons of other cryptos also fell.

The exact reason cryptocurrencies are so tied to the price of Bitcoin is still unclear, says Hanna Halaburda, associate professor at the NYU Stern School of Business. But one possible reason is that those who are enthusiastic about Bitcoin are also enthusiastic about crypto in general, she adds. Another is that the issues plaguing Bitcoin, like environmental concerns and regulatory issues, are issues for the cryptocurrency space as a whole, she adds.

Because diversification with a coin like Litecoin won’t necessarily provide you with diversification from Bitcoin, you want to make sure that your overall portfolio is well diversified with a mix of stocks and bonds. The percentage assigned to each will vary depending on your age, financial situation and goals. And remember that cryptocurrency is not something to bet your savings on, even if you diversify your investments. Financial advisers tend to recommend keeping investments in risky assets between 2% and 5% of your portfolio at most.

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How to diversify your crypto portfolio

So where to start ?

“If you are a new investor, betting on coins and projects that have been around for a while and have proven to be at least not a scam is a good idea,” says Belyaeva. “Investing in something that has been around for a few weeks is probably risky for new investors. “

Bitcoin and Ethereum are expected to make up at least half of an investor’s cryptocurrency portfolio, with the rest made up of other promising coins and tokens, said Greg King, CEO of Osprey Funds, which offers the Osprey Bitcoin Trust. .

Beyond that, it’s best to stick with cryptocurrencies that are definitely legitimate, especially if you’re not too familiar with the crypto space. Sites like Coindesk have a breakdown of cryptos by market cap and provide additional information on each coin.

As for the number of coins to include in your portfolio, it depends on the investor and the tolerance for risk. If you plan to invest in smaller coins, for example, you want a larger number, says Halaburda. And if you’re really concerned about volatility but still want to invest in cryptocurrencies, consider stablecoins, which are backed by a reserve asset like the US dollar or gold.

PieDAO wallets vary in size. Some have 5-6 coins – like DeFi + S, PieDAO’s ‘small cap’ portfolio of high growth, early stage DeFi projects – while others have around 16, including Bitcoin, Ethereum, and others. crypto assets.

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