Knowledge base

What Is Diversification of a Cryptocurrency Portfolio?

Diversifying a cryptocurrency portfolio means allocating funds among different assets. This approach helps balance risks and minimize potential losses.

How to Diversify Your Portfolio?

The principle of diversification is best described by the well-known saying, 'Don't put all your eggs in one basket.' Just imagine what would happen if that basket were to fall. Most likely, all the eggs would break.

The same goes for an investment portfolio if it contains similar assets or, even worse, only one financial instrument. In the event of a significant decline, the investor will incur substantial losses.

To protect yourself from such a dramatic scenario, it is essential to choose several coins for investment, preferably of different types. This will help you evenly distribute risks throughout your portfolio and avoid significant losses if one of the tokens suddenly experiences a sharp decline.

Currently, there are more than 18,000 different digital assets worldwide. However, the vast number of tokens should not be intimidating, as all cryptocurrencies can be broadly categorized into three main groups:

  • Store of value coins (Bitcoin, Ripple, and other);
  • Infrastructure tokens (Ethereum, Solana, and other);
  • Crypto application assets (Uniswap, Compound, and other).

To diversify your portfolio wisely, simply add a few representatives from each group. These can be the most popular tokens or those with the best metrics (market capitalization, liquidity, etc.).

However, keep in mind that the assets you choose should have different risk profiles and low correlation with each other. The latter condition is crucial in portfolio diversification.

If you invest in tokens whose performance is highly dependent on the Bitcoin price and in Bitcoin itself, there will be little benefit from such allocation. During a Bitcoin crash, the entire portfolio will suffer.

There is also another important nuance: correlation is not a stable indicator and can change over time. Therefore, traders need to regularly monitor the market, reassess their investments, and make adjustments to the portfolio when necessary.