11 January 2021
The importance of crypto diversification
We’re all familiar with the expression, ‘don’t put all your eggs in one basket’. The logic is simple - if all of your eggs are in a single basket, what happens if you drop the basket? No more eggs.
By contrast, if you have a collection of baskets and a few eggs in each of them, if you drop one basket, you lose a few eggs. But you still have plenty of baskets left.
Portfolio diversification follows the same philosophy - if you invest in a single asset and that asset’s price crashes, that’s a hit to your entire portfolio. By diversifying, or investing in a range of assets, poor performance in one asset won’t be enough to damage your entire portfolio.
So what does crypto diversification mean? If you’re already invested in stocks, index funds and Bitcoin, are you diversified?
Your portfolio has some diversification, but your crypto assets don’t. Diversifying in crypto means investing in a range of crypto projects, rather than having everything in one or two.
At SwissBorg, one of our goals is to make wealth management and diversification tools accessible for everyone. In our crypto wealth management app, we give our users the opportunity to invest in 12 different crypto assets (with more to come!), including Bitcoin and Ethereum, stablecoins, popular DeFi tokens and more.
Plus they also have the ability to earn a passive income on certain crypto assets, further diversifying their crypto income. Find out more about our Smart Yield account.
Why should you diversify your crypto portfolio?
The main benefit of crypto diversification is protecting against risk. While mitigating the risk of crypto is almost impossible, by investing in a range of crypto assets as well as well as benefiting from passive income on stablecoins, you reduce the impact that volatility in any one asset will have on your portfolio as a whole.
Ultimately, this reduces the risk of permanent loss, because even if one asset crashes, your other assets will be performing differently - some may be holding their value, and some may be rising, putting you in a better position overall.
Diversifying in crypto also gives you the opportunity to learn about different coins and projects. While most people are now aware of Bitcoin and Ether, they might not realise that there are thousands of other tokens available (like our own beloved token, CHSB!), with a range of different purposes that will deliver different value (and may have different financial performance) over time.
The final benefit of diversification is the potential to achieve better performance. Some people might look at Bitcoin’s bull runs (especially the current run from $12,000 to over $35,000 at the time of writing!) and wonder if there’s any point in investing in other cryptos - if you’ve backed the winning horse, why bother?
However, while Bitcoin has spectacular bull runs, it has had crashes that are just as remarkable. In fact, in December 2017, Bitcoin’s price fell by 45% from December 17th to December 22nd! This can put a lot of pressure on investors to time the market perfectly.
A diversified portfolio means you are less vulnerable to a single asset taking such a large hit, and you have more flexibility with entering and existing the market due to having more stable returns.
Let’s look at an example that illustrates the importance of diversification.
Investing in BTC vs. a balanced crypto portfolio
Let’s compare the performance of Bitcoin versus a portfolio that has been diversified by adding a fixed source of income - a yield-earning balance of USDC (available through our Smart Yield account).
In the chart above, you can see a comparison of the performance of Bitcoin (the orange line), a portfolio with 50% a weighting of BTC and 50% on USDC (the green line), and a portfolio with 50% Bitcoin and 50% in a yield-earning USDC account based on our Smart Yield account, which pays a yield of up to 20% (the blue line). The starting investment for all three portfolios was $10,000.
If we put aside Bitcoin for a moment and just look at the return on USDC, because USDC is pegged to the dollar, its value stayed at $5,000 for the three-year investment period. However, in the SwissBorg USDC Smart Yield account, that same $5,000 was earning a yield of up to 20%, which was then compounded daily. This meant that the USDC balance in the third portfolio came to $8,231.35 at the end of the three years. That is a 65% return that was completely passive - all an investor would need to do is leave their funds in the account to start earning. Just imagine what the total return could have been if they had regularly topped up their account over time…
Returning to the overall portfolios, though, over the three-year period, Bitcoin’s return ranged from -60.32% a month to +67.15% a month, while the portfolio with yield-earning account ranged from -29.40% a month to +34.33% a month.
As you can see, both the maximum daily drawdown and volatility were less in a mixed portfolio than when investing in Bitcoin only, allowing investors to benefit from the growth in the market while reducing their risk.
At the end of the three-year period, the result was:
- Bitcoin only: $7,829.36, or a loss of 21.7%
- BTC and USDC: $8,914.68, or a loss of 10.9%
- BTC and USDC yield: $13,231.35, or a gain of 32.3%
Is it possible to diversify in crypto?
A common question that comes up regarding crypto diversification is whether diversification is even possible? Most altcoins have some correlation with Bitcoin, so they argue that investing in altcoins isn’t a true form of diversification.
This may have been true in the past. However, today there are a range of crypto projects available that have different purposes to Bitcoin, which may lead to differences in price performance as the market becomes more established. Over the past couple of years, yield farming has emerged as a way to earn an income on crypto through earning a yield, rather than speculating on potential price gains.
This gives risk-averse investors a way to start investing in crypto with more predictable returns, as well as providing large hodlers with a way to earn a passive income on their existing holdings.
Top crypto diversification strategies
So, now that we’ve covered why it’s worth diversifying your crypto portfolio, the next question is how? Here are our top crypto diversification strategies.
1. Diversifying the type of cryptocurrency
As mentioned earlier, there are a wider range of crypto projects available than ever before, which gives you a greater selection of investment opportunities. However, please take note that making a random selection of tokens and putting 10% of your money into each isn’t the best approach.
Instead, identify the different types of cryptocurrencies available, and ensure your portfolio represents each of those types. Different types of cryptocurrencies include:
- Transactional tokens: Tokens designed to be used as a form of currency, like Bitcoin.
- Smart contract tokens: Are protocols such as Ethereum, Binance Chain or Polkadot that allow using blockchain technology to develop decentralised applications, run smart contracts on its own platform as well as peer-to-peer payments.
- Yield-earning tokens: In the SwissBorg app, you can currently earn a yield of up to 20% on USDC, with yields on CHSB, BTC, ETH and more to come.
- Utility tokens: Tokens integrated into an existing blockchain protocol and used to access its services. The SwissBorg token, or CHSB, is an example of a utility token.
- Stablecoins: Tokens that are pegged to traditional currencies and assets, which can provide more stability and less volatility than traditional crypto tokens, like USDC and PAXGold. They are often used to hedge against the market.
2. Diversifying by industry
Like investing in stocks from different sectors to protect yourself should one sector take a hit, you can also invest in cryptocurrencies that fall into different industries. Some of the industries with crypto projects include:
- Decentralised finance
- Data and analytics
- Supply chain
- Artificial intelligence
You can also take the same approach with regional diversification - or investing in crypto projects from different parts of the world.
3. Time diversification
Time diversification simply refers to investing over time. You may have also heard this referred to as ‘dollar cost averaging’.
If you have $50,000 to invest, time diversification means that rather than investing $50,000 at once, you would invest over time - let’s say $1,000 to $5,000 a month. This lowers the risk of having to perfectly time the market in order to make the best return.
For example, let’s say you invested your $50,000 in Bitcoin in September 2017 when it was valued at $3,500, and then you sold in December 2017 at $17,000 - you would have exited with $242,857! Not bad for a three-month investment.
However, what if you’d invested your money in Bitcoin at $17,000, only to see it rise to over $19,000 and then drop to $8,000 in March? Your investment value will have more than halved, falling to $23,529.
This is the risk with trying to time the market. Instead, by investing a small amount at a time, you benefit from both the highs and the lows. If the market falls, you only spent a few thousand of the total amount you had available to invest at that high price point, so it’s not that big a loss - you just continue investing over time, getting more of the asset you believe in at a discounted rate. This lowers the average amount you’ve spent per Bitcoin over time, which means the average profit per Bitcoin also increases as its value goes up.
Crypto diversification conclusion
For long-term investors, diversification makes sense as a way of minimising risk and maximising the potential rewards of your portfolio. And the same is true for crypto.
At a minimum, diversifying your crypto holdings with assets that earn a passive income through a yield and assets that deliver value through price increases leads to bigger gains over time. If you’d like to get more sophisticated, consider diversifying your holdings further by investing in different types of cryptocurrencies, different industries, different regions, and buying in over time.
As mentioned earlier, the SwissBorg app provides the tools needed for crypto portfolio diversification, including the ability to earn a yield on your crypto!
Disclaimer:This document should be considered as marketing material and not as the result of financial research/independent investments.
The information provided in this article, including but not limited to, opinions, products, data, services, tools and materials contained or described in this article does not constitute financial advice, trading advice, or any other type of advice, and should not be interpreted or understood as any form of promotion, recommendation, inducement, offer or invitation to (i) buy or sell any product, (ii) carry out transactions, or (iii) engage in any other legal transaction. They are provided for informational purposes only.
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