The maturing cryptocurrency industry is full of opportunities for traders and investors. With more than 5000 digital assets, it gives a wide choice and at the same time makes it difficult to create a well-rounded portfolio. What assets to pick up? In what proportion? The purpose of this article is to give a brief overview of general rules that will help you compose a cryptocurrency portfolio.
Rule 1. Diversify your risk level
Uncertainty and volatility are typical of the cryptocurrency market. On the one hand, volatility may bring profits. On the other hand, it might result in considerable losses. That is why a core aspect of building a cryptocurrency portfolio is diversification.
Thus, first of all, identify your risk tolerance level. In other words, ask yourself what drawdown wouldn’t make you panic? It depends a lot on your personality. Some of us can stress in case of 15% drawdown (conservative investor type), while others keep calm, being exposed to risk of 50% drawdown (aggressive investor).
The next step is to pick up the right combination of assets (keeping your risk tolerance in mind). If you are rather conservative, it’s worth choosing assets with a low volatility rate or/and large market capitalization (>$5 billion). For example, your portfolio may consist mostly of Bitcoin and Ethereum (60%-80%) that are currently dominant in the cryptocurrency market.
On the flip side, if you are an aggressive investor, you may include a bigger share of more volatile assets, but along with high returns, be ready for sharp declines in your profitability.
Therefore, carefully observe the price dynamics, fundamental factors and market capitalization of the assets and choose those that comply with your risk tolerance level.
Rule 2. Diversify across asset classes (technology)
Also, to decrease the risk exposure, you can diversify your holdings across different asset classes in terms of their underlying technologies. The idea is that one day the market may favor a particular type of technology, boosting the price of the asset tied to it. Thus, pay attention to technology use cases. There is no doubt Bitcoin’s mission is widely known as “a new electronic cash system that’s fully peer-to-peer, with no trusted third party.” But look sharp, there are plenty of success stories.
A good example is Ethereum that gained considerable attention as a platform to develop and run decentralized applications (DApps). Providing a broad variety of services (for example, marketplaces, gambling DApps, supply chain management, DAOs and many more) Ethereum blockchain swiftly became popular and its asset price dramatically increased.
One more illustration is such asset class as “anonymous cryptocurrencies” (for instance, Zcash (ZEC) and Monero (XMR)). Their key purpose is to provide an opportunity to conduct really private transactions (note that transactions in Bitcoin and Ethereum networks are pseudo-anonymous). Hence, with privacy as an essential selling component, these assets also attract traders and investors.
Remember that the technology may be either accepted by global communities, or turn out to be unnecessary / face some limitations (remember that the industry is still young). It is why it is rational to mix assets with various underlying technologies in order to leverage a technological risk.
Rule 3. Diversify risks across industries
One more idea to minimize your downside risk is to choose a diverse set of industries that you consider to be promising. There is an array of industries that are disrupted by cryptocurrencies. Crypto assets are widely used in such sectors as social media, gambling, travel business, computing and so on.
One of the evolving sectors in terms of digitalization is finance, in particular, decentralized finance applications (DeFi) powered by blockchain. According to Cointelegraph, “DeFi moves toward mainstream adoption.”
You can also follow the trend of online services tokenization and buy some tokenized assets of global business. We will add such assets to Bizonex soon.
Thus, stay on top of the news! Monitor the evolving industries to include the most promising assets into your portfolio. At the same time, make sure you don’t put all your eggs in one basket. This way, you are likely to survive during a market crash.
Rule 4. Consider correlation
Moreover, it is recommended to pay attention to correlation between the assets (price dependence). You can balance your portfolio by picking up some assets that are not correlated to the majority of cryptos you hold.
Note that Bitcoin, in general, is considered to lead the market, however, the correlation between digital assets is an interesting issue that is still being researched. The information on cryptocurrencies correlation is open and can be found, for example, here.
Rule 5. Do your own research
This rule is probably the core one. It’s your portfolio and your profits. Therefore, do your best to invest only in reliable assets. Do you remember the hype of 2017/2018? Many investors bought the assets of scam projects without any appropriate due diligence. As a result, they end up with lost money.
To avoid Ponzi schemes like Bitconnect, examine several issues: the technical documentation, the technology and overall asset purpose, the community, the strategy, and competitive advantages. Also, find out what’s the team behind an asset — can you trust them the fate of your portfolio? Check and double-check!
Thus, with the evolving crypto industry, we get both great investment opportunities and risks that makes composing a cryptocurrency portfolio a complex issue. Although each portfolio is individual and depends on risk tolerance, finance and goals of the investor, these 5 rules may serve as a helpful check-list to seize the opportunities and hedge risks.
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