Mastering Crypto Portfolio Diversification: In-Depth Strategy Guide

Written By
G. Dautovic
April 03,2024

The importance of portfolio diversification for long-term success in the investing world is no secret.

Basically all of the wealthiest investors in the world have a well-diversified selection of stocks and assets in their portfolios, but the crypto market is still largely dominated by pure Bitcoin or Ethereum owners.

This is mostly due to the volatility and unpredictable market movements of the hundreds of other crypto coins available right now, but also due to other factors that aren’t inherently present in the stock market.

Whatever the reasons are, the truth is that having all of your money in a single asset goes against one of the core principles of investing, which is why we’ll shine some light on the strategies that you can use as a shield against downturns while positioning your portfolio to benefit from multiple growth trajectories within the ecosystem.

Crypto Portfolio Diversification Strategies

There are a number of key things you should keep in mind when creating a more balanced crypto portfolio, and these are what you should employ and combine to develop a good diversification strategy:

Market Capitalization Diversification

Size of the total market capitalization of an asset has always been one of the key pillars of diversification, and crypto investors usually use this data as a starting point for creating a more balanced portfolio.

Cryptocurrencies are generally split into three market cap categories:

  • Large-Cap cryptocurrencies are those with a market cap of over $10 billion, like Bitcoin and Ethereum, offering more stability due to their established market presence, and proven resilience during market downturns.
  • Mid-Cap cryptocurrencies are those with market caps within the $1-10 billion dollar range, and some of the most notable cryptos in this range are currently Chainlink and Litecoin. These mid-cap currencies are considered more volatile, but provide a larger growth potential than BTC or ETH.
  • Small-Cap cryptos are those with a market cap of less than $1 billion, and offer the highest growth potential, but also come with a much higher risk than more established cryptocurrencies. Investing a smaller portion of your portfolio here can be very profitable in some cases, but we’d advise to keep the total percentage of your investments in small-cap cryptos below 50%.

Use Case Diversification

Aside from market capitalization, you should always consider the use cases or functions of individual cryptocurrencies, as the underlying technology behind them can also be used to build a stronger portfolio.

Payment coins like Bitcoin and Litecoin are designed for secure, peer-to-peer transactions, which is one of the main reasons that the adoption of these coins continues to grow despite volatility.

Etherum and other DeFi protocols and smart contract technologies, on the other hand, aim to recreate traditional financial systems with fewer intermediaries. Uniswap (UNI) or Aave (AAVE) have also shown the potential of this sector, locking in billions in value over the past few years.

Another legitimate option is to create a plan to move a percentage of your gains in one or more stablecoins, like Tether (USDT) or USD Coin (USDC), in order to shield your capital from market downturns and volatility.

Thematic Diversification

If you want to go further than investing into the most prominent cryptocurrencies on the market right now, you can seek to diversify your investment portfolio across various other sectors that have gained popularity in recent years.

For example, you can invest some of your funds in NFTs (Non-Fungible Tokens), which are assets that represent ownership of unique pieces of digital content, offering potential for growth in the collectibles, entertainment and arts sectors.

While NFTs aren’t as popular as during the 2021 rush, the recent bullish run of cryptocurrencies has also reinvigorated the NFT marketplaces.

You can also invest in gaming and metaverse coins and platforms, as there is a growing number of virtual reality worlds and blockchain-based video games which are powered by cryptocurrencies.

Some other ways of thematic portfolio diversification in the crypto space include privacy coins, security tokens, and projects in real estate, infrastructure, precious metals, stocks, bonds, AI and meme coins.

The amount of choices here is vast and can be overwhelming, so if you want to have capital in a number of different sectors and across various themes, we advise that you first get as familiarized with each of your potential choices as best as you can.

Geographic Diversification 

Having a portfolio diversified across projects based in different geographical locations can also be a good long-term strategy, as you can invest in US, European and Asian-based crypto projects, which can in turn help mitigate risk associated with regulatory changes in any specific region.

You can also consider investing in projects from countries that are considered crypto tax havens or those whose economies are shifting toward greater cryptocurrency adoption, while avoiding those countries which have stricter regulations or bans on cryptocurrencies.

To have a successful geographically diversified portfolio therefore requires a high level of attention on the global regulatory landscape.

Technological Diversification

Another important aspect of the crypto market is innovation, as this is still an emerging sector with technological improvements and innovations happening on a frequent basis. 

You can diversify your portfolio based on things like consensus mechanisms like proof of work or proof of stake, or based on layer solutions (Layer 1 and Layer 2), or even through token standards like ERC-20, ERC-721 and ERC1155, basically betting on the technological advancements that could reshape the future of blockchain and crypto, and capturing profit from future breakthroughs.

Temporal Diversification

This strategy, often referred to as “time diversification”, can be implemented in a few different ways, but is, at its core, based on the premise that while markets can be highly volatile and unpredictable in the short term, they follow more predictable patterns over longer periods of time.

Temporal diversification is therefore highly important for those investors with a portfolio based on crypto assets, due to the highly volatile nature of this market, and the prevalence of FOMO (Fear of Missing Out) which often leads investors to react hastily and make poor investment decisions based on short-term market movements and temporary market conditions.

To achieve temporal or time diversification can be as simple as holding, or “HODLing” as it's often referred to in the community, and maintaining your position in a single or more cryptocurrencies for an extended period of time, from several years to even decades, whatever the short-term market fluctuations are in that period of time.

You can also use dollar-cost averaging (DCA) as another method of time diversification, in which you determine a fixed amount of money that you will put into a crypto asset at regular intervals, regardless of the price of your chosen cryptocurrency, which can mitigate the impact of price volatility and remove the need to time the market.

Last but not least, periodic portfolio rebalancing is essential for managing risk over the investment horizon, and can be combined with temporal diversification to adjust for both the timing and composition aspects of your crypto investments.

Bottom Line

As you can see, diversifying your crypto portfolio is an essential part of long-term success, and a process that requires constant research, monitoring and openness to learning and adjusting to market developments and your own personal investment goals. 

Take note of the principles outlined in our article, or even use the help of tools like crypto portfolio trackers to refine your diversification strategy, and position yourself for growth and long-term success in the wildly exciting and emerging world of cryptocurrencies.

About author

I have always thought of myself as a writer, but I began my career as a data operator with a large fintech firm. This position proved invaluable for learning how banks and other financial institutions operate. Daily correspondence with banking experts gave me insight into the systems and policies that power the economy. When I got the chance to translate my experience into words, I gladly joined the smart, enthusiastic Fortunly team.

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