What Does It Mean To Diversify In Crypto?
Nov 3, 2021
A common problem among crypto enthusiasts is their tendency to overexpose themselves to a few tokens with extreme risk. Crypto itself is a risky investment due to its price volatility, but within the industry many enthusiasts will find smaller capitalised tokens are even more volatile than the popular assets such as Bitcoin, Ethereum, XRP, etc.
The “shilling” position adopted by many of crypto’s famous influencers (Pomp, Roger Ver, Craig Wright, for example) intensifies the risk-seeking behavior of crypto enthusiasts. But these influencers, along with their devout followers, tend to show severe overconfidence bias, which can be dangerous when it comes to asset allocation. Pomp, for example, proudly declared back in July 2019 that more than half of his wealth was in Bitcoin - half an entire portfolio allocation is quite the risk. Experts targeted this widespread news about Pomp’s investing declarations, and labeled him “insane”, stating that such an investment goes against everything known about responsible asset allocation.
Diversification is one of the most common mottos by financial experts when it comes to “responsible asset allocation”. They’ll tell you that diversification is imperative to protect your assets against flash crashes, volatility, and even regulatory decisions. Beyond that, diversification can also allow for exposure to assets that make considerable jumps in price, so it is a weighted approach that “covers all of one’s bases”.
So, how should a crypto enthusiast approach diversification when allocating the cryptoassets in their portfolio? A good place to start is the type of cryptoassets in the industry, and understanding these gives one a better comprehension of why an asset is worth thinking about.
High Cap Assets (Lower risk):
A cap refers to “capitalisation” - the total value of all of a specific asset in circulation, divided by its price. We explain it in this article here.
Coinmarket Cap and Coingecko are both services that track the total market capitalisation of cryptoassets, and those at the top of the list have a higher amount of “capital invested” in them, and therefore have a “higher capitalisation”.
Cryptos at the top of this list like Bitcoin and Ethereum are a little less volatile than the others, because the higher the capitalisation of a coin, the less it is affected by new market buys or mass market sells. For example: If you bought or sold $1 billion of Bitcoin today, you wouldn’t necessarily move the price much. It is this that makes higher caps less risky, because they are less prone to large market swings.
Now, technically, Bitcoin and Ethereum themselves are viewed by traditional finance experts as “high risk” assets, but in the context of the crypto industry, they are lower risk than other cryptos due to their reputation and credibility (having been around for longer) and their large market capitalisations.
Utility tokens are cryptos that are used by the specific blockchain in question that allow for various functions to be performed on that blockchain. For instance: ADA is the token of Cardano, AVAX is the token of Avalanche, XLM is the token of Stellar Lumens, etc. These are all platforms where developers are building automated financial products in areas like DeFi, Fintech and InsureTech, and the tokens are used in the processing of various transactions and functions.
Payment tokens are used primarily for payment, especially for cross border remittance. Bitcoin is actually viewed as a payment token because it doesn’t necessarily have any other utility besides payment, but many would argue it now holds the function of being a “store of value”.
Outside of Bitcoin, the primary payment cryptos are Litecoin, Ripple, and Bitcoin Cash. Because these are used on such a widespread basis, they hold their value and are constantly in demand, and have considerable liquidity.
A lot of users in the cryptocurrency industry value privacy in their ability to trade and transact digitally. Which is why cryptos such as Monero (XMR), Zcash, and Komodo (KMD) were created. These coins use remarkably complex cryptography to provide the highest levels of privacy for their users, and have seen significant adoption and success in recent years.
Lower Cap Cryptos (Higher Risk)
A well diversified portfolio includes at least a few lower cap crypto tokens because of the opportunity to catch a moonshot price increase. At one point in history: DOGE was a low cap crypto, as were Decentraland (MANA), Uniswap (UNI), and PanCake Swap (CAKE) - all were found by crypto enthusiasts to provide great potential and thus became heavily invested in, and skyrocketed in price and are now sitting in the Top 35 cryptocurrencies by market cap.
Within these lower cap cryptos include NFT platforms, DeFi yield farming tokens, Decentralised Exchange (DEX) tokens among numerous other industry silos. These are exciting industries, but with so many different projects trying to make it, it’s always hard to know for sure which ones will be successful or not.
Hence, not all lower cap cryptos perform strongly. Many have the potential to go to zero, which is why it’s important to spread one’s allocation accordingly.
So as you can see, there are a myriad of varying options for enthusiasts to explore when they first venture into crypto. One only has to scroll through the likes of Coin Market Cap and Coin Gecko websites previously mentioned to understand just how many digital assets there are in existence. It’s impossible to invest in all of them, but at least understanding the concept and importance of diversifying one’s allocation can already give you an edge.
There is so much yet to come in this industry, and being allocated to a wider spectrum of projects is an important step in building your crypto strategy. MEX Digital is always here to assist you in your crypto journey, and we invite you to subscribe to our newsletter and follow our blog.
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This is not financial advice