How Does Diversification Work?
Cryptocurrencies have emerged as one of the most popular investment drivers in the last few years. From established digital currencies like BTC and ETH to relatively new-to-the-market coins such as LINK and AAVE, traders are relying on the modern asset class to build their investment portfolios.
Having said that, it should be kept in mind that cryptocurrencies, with the exception of stablecoins, tend to be substantially more volatile as compared to traditional assets including stocks, commodities, and forex. This is exactly why it is important to ensure that you diversify your trades and avoid putting all of your eggs in one basket when investing in digital currencies.
Diversification of Portfolio - What Does It Mean?
Diversification is one of the most popular risk management approaches that propose instead of investing all of your capital in a single coin, you should strategically spread it across a variety of cryptocurrencies. When you have a diverse investment portfolio, it comprises different coins and virtual currencies so you don't become vulnerable to market fluctuations and price volatility.
The primary idea behind this risk management strategy is that when you create a diversified portfolio that contains different types of assets, it has better odds of leading to higher returns in the long run. It also reduces the risk of being fully invested in only a single asset. That's the reason in the crypto investment world it is often said that you shouldn't put all of your eggs in one basket.
How Does Diversification Work?
When the price of one coin drops, diversification may help you to minimise your financial loss and even help you make money. Some coins will be affected by the price reduction, but not all of them will be affected at once as it is statistically improbable. If the price of one or more cryptocurrencies drops, the others will stay steady or even increase in value, giving you a financial safety net. Even if you lose some money, the overall impact will be favourable or neutral, and you'll still have most of your original investment.
- Non-Diversified Investment
Imagine the price of Cryptocurrency A is €100 per coin and you invest €5,000. There is no diversity in your portfolio now that you've placed all of your money in one currency. It is now possible to lose €2,000 if the price of Cryptocurrency A drops by 40% and falls to €60. To get your money back, you must wait and see whether prices increase in the future or sell at the current price to limit any further losses.
- Diversified Investment
Imagine the price of Cryptocurrency A and Cryptocurrency B are €100 and €50 respectively and you invest €5,000 equally in both. It means that you have invested €2,500 in each coin. If the price of Cryptocurrency A drops by 40%, you will only lose €1,000, rather than losing €2,000 as before. On the other hand, even a 20% increase in the price of Cryptocurrency B will net you €500 making your net loss only €500.
Just by adding one more coin to your portfolio, you have reduced your loss margin by 75%. Apart from that, you now have a chance to wait out the market as even if one coin continues to decline in value, the other digital currencies can still give you a net profit. This is the reason why having 5 to 15 cryptocurrencies in your portfolio is a much better choice than investing all your money in a single token.
Built-In Portfolio Diversification with Coinpanion
Coinpanion enables you to invest in pre-determined portfolios with varying degrees of risk appetite. There are five different types of portfolios containing 6 to 14 cryptocurrencies for diversification.
This portfolio is for disciplined investors who want to avoid market volatility at all costs. When you invest in this portfolio, 80% of your money goes towards USDC which is a stablecoin backed by a fiat currency such as USD. The rest of the capital is spread across numerous coins including BTC, ETH, MATIC, XLM, AAVE, ADA, DOT, and more.
As the name suggests, this portfolio attempts to create a balance between risk management and profitability. 40% of your capital is invested in USDC while the remainder 60% goes towards a wide range of digital currencies including BTC and ETH.
When you are not worried about the crypto market's volatility, this portfolio provides you with the opportunity to take all the risk. 100% of your capital is invested in cryptocurrencies with the potential of a high return.
This portfolio has been specially created for those investors who want to acquire a financial stake in Metaverse. Your capital is spread across different digital currencies including ETH, MATIC, MANA, ENJ, SAND, and AXS - basically, all the coins that empower virtual reality and NFT infrastructure.
This portfolio has been specially created for those investors who want to acquire a financial stake in the open financial ecosystem, known as DeFi. Your capital is spread across different digital projects in the industry including smart contract protocols, lending platforms as well as decentralised exchanges.
Final Word
A contemporary crypto investor must diversify his or her portfolio to ensure adequate risk management. However, you may find it difficult to build and keep track of your diverse portfolios on a frequent basis. When it comes to achieving your investment goals and objectives, Coinpanion has a variety of crypto investment portfolios with built-in diversification so you can easily select one that aligns with your expectations.
