The cryptocurrency market is a highly unstable phenomenon. And it is quite possible that when you wake up in the morning and check the state of assets, you will find that all your investments have literally disappeared since the price of the only asset that you focused on has fallen. Unfortunately, this happens quite often, since so many novice traders have no idea that bitcoin is not the only cryptocurrency. Meanwhile, the amount of existing types of cryptocurrencies goes to thousands.
Therefore, an experienced investor will devote some time to collecting information about what constitutes the most common of these assets. And this is the first step towards the effective diversification of his cryptocurrency investment portfolio.
What is diversification and its applied value
At the simplest level, this is a banal variety. You buy various coins, tokens and digital money, so if the price of one asset suddenly drops, the profit from others could compensate for this loss. And taking to attention the high volatility of most cryptocurrencies, this can happen regularly.
However, not all is so simple. According to the founder of HodlBolt, one Anthony Xie, almost all cryptocurrencies are interconnected. There is a strong correlation between their prices. Yes, and they react in a similar way to the events that affect the cryptocurrency market in total. Therefore, it is impossible to achieve complete diversification, in which assets are completely independent of each other.
However, not all experts agree with him. In 2018, the Crypto Briefing magazine partially refuted the above statement, pointing out that cryptocurrencies are becoming more and more independent from each other.
What factors to consider
There are certain criteria that make the coin or token a good choice for forming a diversified cryptocurrency portfolio. Putting it simply, they look as follows.
Usage or Functionality
Each cryptocurrency has its own main goal and a number of tasks. Use as a method of payment under certain conditions is only one of them. Therefore, before forming a diversified investment portfolio, you need to figure out what you will be dealing with. At a minimum, to understand what the main task is.
It looks like this:
- Use in information technology and the creation of a "world computer": Ethereum, NEO, Tron and Cardano
- Method of saving assets: Bitcoin
- Decentralized Application Component (DAPPs): Steem and Augur
- Payment Networks: XRP, Stellar and Bitcoin Cash
- Stablecoins: Tether, USDT and PAX
When you form a diversified portfolio, you need to choose coins that belong to different categories.
Majority of cryptocurrencies have a very narrow purpose, due to which the number of people who interact with them is reduced. For example, Steam’s own currency is not interesting to anyone outside this part of the gaming community. Therefore, it is imperative that the few stakeholders are active and purposefully contribute to the further growth and expansion of the popularity of their community. This is perhaps the best way to achieve a stable price.
Using new technologies
At the current moment you can’t just take the open Bitcoin code, slightly change it and call it “your own cryptocurrency” - it will turn out to be unviable, because the technical solutions described in it's whitepaper are outdated. Therefore, really effective blockchains are required to introduce new technologies or improve old ones. At a basic level, you need to find out whether the problem of scaling is solved in the system, and if is, how exactly? The same goes for security. Are new security protocols implemented? Which smart contracts are used? Is it possible to add add-ons to an existing chain?
Not all cryptocurrencies are completely decentralized - in many such projects there is a full-fledged guide that decides on organizational issues, determines the future direction of development and is responsible for the issue and distribution of new coins. It is also worthwhile to figure out what exactly makes this currency attractive for investors - what incentives are used for them? How do new coins appear and do they even appear? Does the system support mining or related processes? Is their number limited?
It makes no sense to try to invest immediately in everything possible - this will complicate the process of tracking the situation in the markets. Usually, it is recommended to focus on 3-7 different cryptocurrencies and work exclusively with them.
The main investment asset, however, is better to do either Bitcoin or Ethereum. They are the most famous, stable and reliable among all proposed options.
In addition to the above categories, it also makes sense to pay attention to other points:
- Liquidity of the selected asset.
- The age of the industry in which the asset is used and its size. The older, the better.
- The volume of investments from traditional financial organizations. They are rarely associated with unstable and unpredictable currencies, so they can be used as an indicator of reliability.
As you can see, it is possible to diversify a cryptocurrency portfolio correctly, but quite difficult. You will have to spend time to understand the basic technical points, not to mention macro- and microeconomic indicators. Therefore, it is not surprising that many investors delegate diversification to specialists. This, of course, is an additional cost, but stability is worth it.