Balancing Risk: Crypto Portfolio Diversification Strategies

The Ultimate Guide to Crypto Portfolio Diversification: Keeping Your Investments Balanced and Secure

Have you ever heard of the saying: “Don't put all your eggs in one bag”? Surely you have.

That's what diversification intends to do: to not invest all the capital in one single asset but to sort it out across a group of selected financial instruments. The art of “the maintenance of capital”.

In the crypto world, it’s vital to have a crypto portfolio that puts diversification on top of its strategy. Since crypto assets are very volatile, this market may be as profitable to winners as un-profitable to losers.

Through this article, investors will learn:

• The importance  of diversification in regard to taking risks and benefits from crypto markets.
• Strategies and how to implement them, with real examples.
• What to avoid while building crypto portfolios.
• What cryptos there are in the market, types of sectors, and how to use Altrady.com to explore, build, and test portfolios.

The Rise of Digital Assets

Blockchain, the technology behind cryptocurrencies, has become a movement that’s been going ahead and breaking all of the preconceived concepts of traditional investments; it has, in fact, modernized the investing sector.

Not only by providing new infrastructures, which could be a big plus point in itself, but also by bringing a wide variety of new instruments to the money table, like NFT, Game-Fi, DeFi, AI, Internet of Things (IoT), ads, and even networks.

Almost anything is being tokenized nowadays; it is happening in all kinds of contexts. Let’s quickly point some out:

• Art: works monetized in the form of an original record backed up into the blockchain. This is the world of Non-Fungible Tokens (NFT).
• Gaming: players now win rewards while having fun. They swap them later through a DeFi processor like Pancakeswap.

There are many notable aspects that we could point out about a cryptocurrency as an asset class, but the fundamental one, its promise, is its decentralized nature. That’s what makes Bitcoin the main currency of the entire crypto world.

Beyond other points like privacy, decentralization is where the attractiveness of this asset class as a financial instrument is based. The inability of a central entity to interfere with supply and demand for most cryptocurrencies allays concerns about inflation and therefore depreciation, for example. The market and only the market can move the price of a crypto asset.

The truth is that there are other forms of manipulation: news, propaganda, trusted personalities, bad practices by exchanges, and so on. But even these forms depend on the group of participants we call the market and their willingness to buy or sell a crypto asset; there is so far no way to manipulate the price of Bitcoin with artificial artifacts like altering suppliance as occurs with some traditional instruments.

Understanding Crypto Portfolio Diversification

What is Diversification?

Diversification is a management concept that will try to reduce the risks of big losses in an investment portfolio. Focusing on controlling asset volatility, its goal is to cover a loss in one instrument by offsetting it with gains from another instrument.

Why does it matter for reducing risk?

Diversification provides investors with a framework for assets, as a macro representation, from which to leverage and offset risks, as well as track their capital smartly. This allows for quick decision-making to adapt to different market conditions, as well as deep comprehension of the strategy performance.

How Diversification Works in Crypto

Like any other market, the crypto one has several assets to choose from. Generally, the market splits in two: Bitcoin, and the rest… the altcoins. Bitcoin is the dominant coin with its own blockchain. Now, there are other coins and blockchains too.

We have:

• Coins by blockchains
  • Bitcoin (BTC).
  • Ethereum (ETH).
  • Dogecoin (DOGE).
  • Solana (SOL).
     
• Tokens
  • Issued by exchanges.
  • Decentralized Finances tokens (DeFi).
  • Governance tokens.
  • Wrapped tokens.
  • Non-fungible tokens (NFT).
  • Meme tokens.
  • GameFi tokens.
     
• Stablecoins
  • For fiat money, like the dollar: USDT (the most popular, by Tether), USDC (By Circle), or BUSD (Binance native stablecoin). There are also for the euro, the pound, and so on.
  • Collateral-crypto: Tether is the company behind USDT or Coinbase behind Circle, they are the custodians of dollars for physical reserves for their stablecoins, for example. Instead, Crypto stablecoins are backed by smart contracts.
  • Commodity stablecoins: this type covers more traditional instruments like oil and metals. Tether Gold (XAUT) is an example of a stablecoin backed by a precious metal for crypto investment.
  • Algorithmic: similar to smart contracts, this type uses an algorithmic approach for price and suppliance regulation of a token.

The Benefits of a Balanced Portfolio

Which asset to add may not be the only thing to think about when building a portfolio, but also how to balance it properly.

This is important because an investor could have a good strategy for selecting assets, but these might be very volatile during a certain period (a quarter, for example) and therefore the capital does not grow or worse, falls a considerable percentage.

Preserving a balanced portfolio is intrinsically correlated to a healthy risk/reward, which maximizes profits while risking the minimum; that is what every investor should look for.

A portfolio that grows constantly can increase the risk tolerance, hence the capital power. Having more profitable positions could offset any wrong decision.

Is it better to have two very volatile assets that could rise 40-60% in the short term or to have six assets that rise 10% in the long term consistently? Surely the experience and risk profile of the portfolio manager will play a role, but a well-respected strategy like DCA will do much better with all six assets.

Key Strategies for Diversifying Your Crypto Portfolio

Market capitalization of a crypto means the value of the total coin in the market that is in circulation. This suggests that although market capitalization provides an idea of the size of a cryptocurrency the metric in question is not necessarily liquidity. Liquidity, conversely, is the ability to buy or sell the asset without causing substantially large price shifts.

High liquidity means there are many orders in the exchange order book to support the stability of the price and reduce volatility. Understanding both market capitalization and liquidity is essential for choosing assets and setting the overall risk-to-reward ratio of your portfolio.

Having just high-cap crypto instruments in your portfolio won’t bring big returns quickly, but for sure it will grow in the long term conservatively.

Mid-cap strategies demand higher risk exposure with the promise of substantial returns in an attractive time frame. Entering early in one of these could lead to a long-term very good investment decision since they’re on the way to becoming high-cap assets.

The small-cap could be seen as a purely speculative vehicle and not an investment, in the strict sense of the word. Assets of this type could be added to a portfolio for a very short time frame and for very specific reasons or purposes.

Depending on the risk tolerance profile of an investor, it could:

• Great tolerance: to invest 30% in low-cap (meme coins), 40% in mid-cap (like Solana), and 30% in high-cap (Bitcoin, Ethereum).
• Middle tolerance: to invest 35% mid-cap, 45% high-cap, 15% low-cap.
• Lower tolerance: 60% high-cap, 30% mid-cap, 10% low-cap.

Diversifying by Industry or Sector

A good approach to implementing a cryptocurrency selection strategy is sorting them by their specific industry.

The DeFi sector is based on application developments that offer various tokens. Investing in DeFi could be an option to consider because most of this industry relies on the Ethereum Network, which is the second high-cap asset of the entire crypto world.

Mixing Ethereum, a high-cap asset class, with some DeFi tokens (mid-cap), could bring a good balance to your portfolio. Even meme coins (low-cap) operate in Ethereum; Vitalik Buterin, the Ethereum founder, wrote a blog in March and said: “The value might go up, they feel democratic and open for anyone to participate, and they are fun”, in reference to why people participate in these coins.

The same approach works for the GameFi sector. In this case, Buterin says:

The answer for (iii) is simple: don't just make a coin, make a game. But make an actually meaningful and fun game. Don't think Candy Crush on the blockchain; think World of Warcraft on the blockchain.

Some successful games like FrogCrypto have met those expectations: being fun and meaningful. The play-to-earn concept has risen considerably well; however, it has been criticized by respected figures in the gaming community. An industry to put an eye on if you like gaming.

The NFT sector is tremendously speculative and could be hard to maintain in a portfolio if you don’t know the sector deeply, it seems imperative to keep an eye on the whales of this industry and learn to play the rules of the specialized marketplaces in which these assets operate.

Layer-1 blockchains are another attractive sector. Related to Web3, it’s consistently improving. Layer-2 chains have emerged too, Coinbase launched its L2 network on Ethereum by the hand of the Optimism project.

Having some quantity of Ethereum, DApps from Base, accompanied by Optimism, could be an excellent way to empower your portfolio by selecting specific options from a sector, powered by a big company, secured by the second high-cap crypto project. Coinbase has performed very well even in the traditional stock market.

Examples of sector-specific coins:

Common Pitfalls to Avoid

Starting to add crypto assets to a portfolio requires special attention to not fall into critical situations of dependency in a single ecosystem and not even know it. Falling in love with a specific project isn’t a professional practice; an investor has to be rational, not emotional.

Letting our decision-making process be conducted for some kind of propaganda could significantly harm the capital. Modifying our percentage investment to open a position motivated by some guru or trend, isn’t acceptable for diversification strategy success.

Be aware to not be a victim of “FOMO” or “FUD” news, and avoid extreme greed or fear, you can solve this by conducting research and reading the market sentiment. Altrady explains this well in this blog entry.

To illustrate examples of this pitfall to avoid, let’s think of the recently collapsed crypto exchange FTX. This issued its own exchange token FTT.

FTX was highly promoted by prominent figures from several fields. Now think of an investor who had a 70% position on FTT when the collapse was announced, sure its portfolio suffered a major loss, as, in fact, it happened to clients.

Another recent case to mention is the Terra/Luna collapse. Large losses in this case reached the portfolios of retail investors and big capital managers. Again, Terra enjoyed a great promotion and rapid acceptance.

Diversified Crypto Portfolios Types

Sample portfolio for risk-averse investors:

Sample portfolio for balanced risk:

Sample portfolio for risk-tolerant investors:

Note the riskier it gets, a portfolio is less diversified.

Day Trading and Diversification

Up to this point, you could have noticed that managing a portfolio is mainly about holding assets for the medium and long term. But do investors have chances of making profits from day-to-day movements? Yes, they do. Is it compatible with a diversified portfolio strategy? It is.

Day trading should be part of every portfolio management strategy. This way of getting into the market allows the investor to capitalize on short-term movements.

This is done in one day, per session, and a day trader may open multiple positions for multiple cryptocurrencies at the same time until the end of the day when these positions are closed.

Day traders make profits when a coin goes up or down. Integrating day trading strategies with diversification might help not miss profits in reversal movements of an asset.

Instead of selling the asset from the portfolio, the investor could “short it”, meaning opening a position in a down direction for a specific period of the day, taking advantage in favor of the overall capital without compromising the portfolio diversification.

Day trading requires mastering the charts and indicator tools, in this article, Altrady dives into the best cryptocurrency charting tools.

Pro Tip: Leveraging Correlation in Crypto Trading

When it comes to buying or selling in the crypto market, it's crucial to recognize that Bitcoin often acts as the flagship and trendsetter. Typically, when Bitcoin falls, most other cryptocurrencies follow suit, and when Bitcoin rises, they generally rise as well. The correlation between Bitcoin and many altcoins is often greater than 80%.

What does this mean for day traders? If you’re considering selling in the crypto market, it’s wise to sell several different coins rather than just one, because each may react with varying intensities to market movements.

Example: If a shorting opportunity arises, you should consider selling the coins that have a higher correlation with Bitcoin. This way, some assets might hold their position firmly, while others could decline rapidly, offering a better chance of profit. This diversified approach helps you avoid being stuck in a single trade with limited potential.

By diversifying your trades, you can balance out risks and enhance your chances of capturing profitable moves in the volatile crypto market.

Utilizing Altrady for Portfolio Diversification

Altrady is an all-in-one solution for beginners and advanced traders that offers all the necessary tools to manage portfolios, for self-purposes or third parties like clients of a professional asset manager.

In the platform, a trader will find the most sophisticated tools to analyze and put orders in the market, even other tools the trader didn't know would need.

In the same way, important aspects like the risk-to-reward ratio are covered by Altrady. A trader can use the Risk-reward calculator to help with that.

One of the most useful tools offered is to track the performance of different accounts from several exchanges, all from one single trading suit.

Track portfolios from Binance, Kucoin, Coinbase, and so on, while diving deep into their cryptocurrency holding and tracking progress over time.

Connect your API keys, and the system will automatically fetch the data from the exchanges.

The system will check your assets several times per hour or when trade activity is detected. This will get you a real-time overview of your assets.

No more manual export and conversions in Excel are required.
*Note: this feature is for premium members only.

To summarize:

1. Connect accounts
2. Manage assets
3. Aggregate data
4. Analyze Performance

Discover more on how to build and maintain your portfolio successfully, by clicking here.

Conclusion

So far, we have learned a lot to start building and maintaining a portfolio, let’s recap the most important points:

1. Avoid putting all the capital in one asset class or crypto industry.
2. A portfolio can be integrated with a day trading strategy.
3. Know your risk tolerance to be able to build the most proper asset class combination: successful portfolios have a proper balance.
4. The importance of diversification for success.

Remember that diversification aims to reduce the risks of big losses while gaining the most possible. Keep an eye always on the risk/reward ratio.

Diversification could offset losses of a determined asset but don’t try to abuse this.

Conduct good analysis and keep a proper balance instead. The offsetting will come as a result of balancing properly.

Diversification will provide worthy information on your strategy, and which asset classes are doing well, and which are not.

Would you like to start applying what you have learned today? Start Paper Trading with Altrady’s FREE plan, the unique paper trading plan on the internet today you can’t miss.

Save this article in case you need to recap some concepts, and you can share it with colleagues and friends. or even clients who are skeptical of the diversification strategies.