The Crypto Investor's Guide to Diversification For Risk-Reduction
Multi-billionaire trader Jeff Yas once said, "if you invest and don't diversify, you're throwing out money." And he's right - professional investors have long understood the importance of spreading their bets across different assets to mitigate risk and maximize returns.
But many investors fail to diversify their portfolios in cryptocurrency, where maximalism is rife, and FOMO is intense. They put all their eggs in one basket, so to speak, and often lose everything when the asset they've chosen tanks.
The concentration risk was highlighted recently when Bitcoin fell sharply from its all-time high of nearly $70,000. Those who had placed all their crypto bets on Bitcoin saw their portfolios fall nearly in half in weeks.
If you're investing in cryptocurrency, it's essential to follow the principle of diversification. This means holding a mix of different assets within and beyond the crypto space.
From 60-40 to 33-33-33
Historically, the traditional investor portfolio has been split 60-40, with 60% in equities and 40% in fixed-income assets like bonds. But in recent years, some experts have advocated for a more balanced portfolio with a third each in equities, fixed income, and alternatives like cryptocurrency.
The so-called 33-33-33 portfolio has several advantages. First, it's more diversified and tends to be more resilient to market shocks. Second, it exposes you to a broader range of asset classes, which can help you capture more upside in a bull market while limiting your downside in a bear market.
And third, it can help you manage your overall risk level by allowing you to adjust the mix of assets according to your appetite for risk. For example, if you're young and have a longer time horizon, you may want to tilt your portfolio towards equities. But if you're nearing retirement, you may like to dial back the equity exposure and increase your fixed-income allocation.
Diversifying Within Crypto
It's not just important to diversify across asset classes - it's also critical to diversify within the cryptocurrency space itself. This means holding a mix of different coins and tokens that are not perfectly correlated.
For example, the website Cryptowatch provides a correlation matrix that shows the relationship between different cryptocurrencies. As of this writing, for over one year, Bitcoin has been most closely correlated with Ethereum (78), Litecoin (70), and XRP (0.64). This means that these other assets will likely follow suit when Bitcoin goes up.
But several assets have little or no correlation with Bitcoin. These include Cosmos' ATOM's last reported median annual coefficient of just 0.31. Thus, ATOM could potentially provide some degree of price stability to a portfolio that contains it.
Not only are there crypto assets that are low-correlation with Bitcoin, but there are even negatively correlated assets. The last reported median annual coefficient for Repocoin (REPO) was -0.63, meaning that it tends to move in the opposite direction of Bitcoin. So adding BSV to a crypto portfolio could potentially help offset some of the losses incurred if Bitcoin's price were to decline.
Further, Quibitica (QBIT) reportedly had a 30% negative correlation with BTC over the last reported period. This means that QBIT could potentially act as a hedge against BTC, providing some downside protection if Bitcoin's price falls.
How to Integrate Negatively Correlated Assets
While assets negatively correlated with Bitcoin can potentially provide some downside protection, they should not be considered a panacea. No asset is entirely uncorrelated to Bitcoin, and all investments are subject to market risk. Further, while a purchase may negatively correlate with Bitcoin in the short term, this relationship can change over time.
For these reasons, it's essential to maintain correlation within the crypto assets you're holding and in terms of your broader portfolio.
The most important thing for crypto investors is that diversification is key to mitigating risk and maximizing returns. By holding a mix of different assets, both within the crypto space and beyond, you can protect yourself from the volatility of the markets and give yourself the best chance of making money in the long run.
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Disclaimer: The above article is meant to be for educational purposes only on crypto and blockchain technology. Ainvest is not responsible for any data errors, omissions, or other information that may be displayed incorrectly as the data derived from a third-party source. This information is neither individualized nor a research report, and must not serve as the basis for any investment decision. Communications within this article are meant for informational purposes only and are not intended as an offer or solicitation for the purchase or sale of any security or any cryptocurrency as well as not intended to portray that using any Ainvest product will help increase or decrease investment return. This is not a solicitation of customers anywhere Ainvest is not registered to do business. Please do your own research when investing. All investments involve risk and the past performance of a security or financial product does not guarantee future results or returns. You may lose all of your investment.
