8
min read

Asset Allocation: How to Diversify Your Crypto Portfolio

Crypto portfolio allocation involves identifying the percentage of crypto in your overall investments, then choosing the blend of cryptocurrencies that match your risk appetite.

If you are involved in investments of any sort, diversifying your portfolio is crucial to hedge against the risks involved. It means that you have to invest in different kinds of assets in such a way that the growth of others will balance out possible deprecation of some of them, and in the end, you will still end up with a profit.

There are two levels to portfolio diversification:

  1. Investment in different sorts of assets.
  2. Allocation of same-type assets.

For example, on the first level, you may invest in stocks, bonds, real estate, art, and crypto. On the second level, you choose which stocks and bonds go to which fund, make sure to have various sorts of real estate, buy pictures by both promising and renowned artists, and have numerous different crypto coins. That’s what asset allocation basically is.

In this feature, we shall look at some best crypto portfolio allocation ideas, talk through typical techniques and risks involved in crypto allocation, and cover other important issues relevant to the case.

The Importance of Asset Allocation

Asset allocation is a crucial part of investment strategising, with some research suggesting that over 90% of the difference in the performance of two portfolios comes down to it. Even conservative estimates place it as one of the most important factors influencing the success of a given portfolio.

Finding the blend of assets that perfectly matches your needs might take time but is always possible. In most cases, it comes down to your risk appetite: the bigger the share of high-risk assets in your portfolio, the higher are your potential gains or losses. Still, a sensibly built portfolio is a great way to hedge against losing all the capital, and spreading your investment across a wide range of asset classes will let you diversify your holdings and even out your risks. 

Cryptocurrency Promise Higher Returns vs. Traditional Investments

Over the recent years, crypto has been gaining steam as a legit part of an investment portfolio, as it promises higher returns than traditional investments. For reference, over the past year, the returns of S&P 500 is at 33%, while Bitcoin is at 245%, with the Cryptocurrency LargeCap Index (consisting of cryptocurrencies with the largest market capitalisation) at 302%.

Return comparison chart of S&P 500, Bitcoin, and Cryptocurrency LargeCap Index
Image 1:  S&P Global, tracking S&P 500®, Bitcoin Index, Cryptocurrency LargeCap Index


The high profitability of this new asset class makes its inclusion reasonable and desirable, while the ongoing regulatory recognition and technological advancement of the entire blockchain industry promise even higher yields in the future. Crypto platforms offer a wide range of crypto-asset types whose varying properties give one a multitude of investment options to choose from or combine.  

Low Correlation of Crypto with Traditional Investments

Besides high profitability, another reason for the popularity of cryptocurrency is the low correlation it shares with traditional investments like stocks and bonds, where correlation measures how different asset prices move relative to one another. This showcases crypto as its own distinct asset class and makes a strong case for bitcoin as a store of value, as seen in the chart below by Wellington Management. Bitcoin’s highest positive correlation lies with EM (Emerging Markets) equity at 0.24, but any value below 0.3 still represents almost no positive correlations between the two asset classes.

Bitcoin’s correlation to traditional assets
Image 2: Bitcoin’s correlation to traditional assets

While the reasonable share of crypto in a portfolio varies from 1% to 30% depending on your risk appetite, it is sensible to start with smaller amounts if you are new to it. If you dedicate only a small fraction of the entire basket of assets to crypto, you will be able to see how it performs over time and make your decisions accordingly. Gradually increasing the invested amount—say, by reinvesting the profits—you could sensibly expand the crypto part of your portfolio.

Crypto portfolio allocation is as important as in traditional finance, so even going for 1% suggests that there should be different kinds of crypto in your portfolio. So how do you get started?

How to Add Crypto to My Portfolio?

Unless you deal in really big money, in which case OTC (over the counter) trading would probably be your best bet, you can simply go to a cryptocurrency exchange and buy the desired amount.

When choosing a cryptocurrency exchange, compare their terms and conditions and stay alert for hidden fees. Here are some questions to consider when you’re doing your research:

  • Is the exchange regulated in a financially respectable jurisdiction like the US or the EU, or is it an offshore venture?
  • Is the price the same at the start and end of your purchase?
  • Are there unexpected transaction fees that could put a dent in the amount of crypto you can buy?
  • If you’re planning to engage in a time-sensitive transaction, how long does it take to complete a purchase on the platform?
  • What cryptocurrencies are tradable at the exchange?

Unless you have a very high risk appetite, the most reasonable way would be to work with an exchange recognised under US or EU laws, with transparent pricing and without unexpected transaction fees, and keeps away from dubious cryptocurrencies, mostly focusing on top ones. There is a selection of exchanges that fit those criteria, and working with them ensures you will not have much trouble with banks or tax authorities.

You can also buy crypto easily via SEPA, Faster Payments, or Plaid with Cabital, depositing EUR or GBP and converting your cash to BTC, ETH, or USDT. Once you've converted your cash to crypto, it's time to start thinking about how to put your crypto to work.

Crypto Investment Strategy #1: HODLing

Once you have bought your crypto, there are several options as to what to do next. The first is so-called ‘HODLing,’ a crypto term that means that you hold on to your crypto assets for years in the hope that they eventually will grow more expensive. You don’t have to do anything except be patient. This strategy worked great for those who bought Bitcoin at its lows. Still, there is not even the slightest guarantee that this strategy will work as intended, and regular returns are out of the question, too. Plus, the dramatic market swings seeing Bitcoin lose half its price over a couple of days require that you have nerves of vibranium to keep HODLing. But while the risks are enormous and the tension is sky-high, so are the potential profits (or losses).

Crypto Investment Strategy #2: Trading

You could also use your crypto to engage in daily trading at an exchange of your choice. The process is similar to trading stocks or commodities yet the risks are higher due to crypto volatility. Additional risks come from the fact that crypto trading might be banned or frowned upon in certain jurisdictions, as well as the history of crypto exchange failures. This is arguably the riskiest strategy of them all where potential gains are enormous, but so are potential losses. The golden rule of trading is to never put at stake more than you can afford to lose.

Crypto Investment Strategy #3: Yield Farming

Finally, there is yield farming, a process mostly associated with DeFi crypto platforms. In this case, you use your funds as a loan to provide liquidity to the platform in exchange for rewards coming from trading fees. The model is risky as well. For example, those loans are susceptible to losses caused by smart contract bugs, hacks, the organiser’s dishonesty, or abrupt market swings. Being a form of passive income with potentially high returns, yield farming still requires serious crypto experience from the investor.

Crypto Investment Strategy #4: Depositing

To remove the risks from the equation to the maximum possible extent, you can consider putting your crypto to work to generate a steady flow of passive income that might not be as high as from lucky trading or yield farming. It’s like HODLing, just that you earn a constant stream of income from the coins that you’ve deposited with a wealth management platform like Cabital

Depositing works like a traditional savings account, just with cryptocurrency instead of cash. You deposit a sum of crypto with Cabital, and our investment team will put your crypto to work by investing in the best opportunities while mitigating risks within reasonable constraints. As mentioned in another post, Cabital does not place a lower limit on your investment, so you can test the waters with small sums of USDT on the 30 Day Fixed Savings plan with 6% APY.

Table 1. Comparison between the ‘Depositing’, ‘HODLing’, ‘Yield Farming’ and ‘Trading’ strategies
Table 1. Comparison between the ‘Depositing’, ‘HODLing’, ‘Yield Farming’ and ‘Trading’ strategies

Diversify Crypto Portfolio to Mitigate Risk

Bitcoin alone can showcase what mind-boggling volatility can be. Yet, crypto is not just bitcoin. There are also Ether, BitShares, Tether, Ripple, DAI, and lots of other notable crypto assets. If you invest just in one cryptocurrency and it tanks, there is little you can do about it except to concede sadly. But if one crypto-asset in your portfolio plummets then having others on hand can save you from losing overall

The more crypto-assets you get, especially those considered blue chips of their realm like bitcoin and Ether, the better off your portfolio is in mitigating the crypto risk. Besides investing in more typical cryptocurrencies, you can also invest in stablecoins, which offer higher interest rates due to market demand. 

It is similar to buying stocks in the same industry: even if some of them fail, others will prevail and cover for all the collateral losses. In a similar fashion, the risk commonly associated with crypto is spread out across multiple assets and thus mitigated, though not removed altogether. 

What Cryptocurrencies Should I Use to Diversify My Portfolio?

A diversified crypto portfolio with reasonable asset allocation would include different kinds of cryptocurrencies. While there are numerous ways to classify them into various groups, such as the extent of their centralisation, their consensus algorithm, or backing, in terms of investment, the most fundamental criteria are their economic foundation and financial performance over the years. 

Generally, there are three viable types of crypto to consider when you're planning your crypto portfolio allocation. Based on your risk tolerance, you may choose different crypto projects and crypto types to include in your crypto investment portfolio allocation.

Stablecoins

Stablecoins are cryptocurrencies pegged to or collateralised by other assets to keep their price stable, hence the name. In terms of crypto-asset allocation, their features include:

Price comparison chart of Bitcoin, Ethereum, and Tether
Image 3: Graph generated with CryptoCurrencyChart.com
  1. They are the most stable crypto option out there: the asset’s steady price ensures hedging against crypto’s volatility, especially in the bear market. While typical cryptocurrencies like BTC and ETH have drastic gains and losses, USDT remains stable, keeping its value of US$1.
  2. They are arguably the perfect gateway coin for those new to crypto, showcasing all the advantages of cryptocurrency without exposing its users to significant financial risks.
  3. Stablecoins like USDT are commonly used to service cryptocurrency trading and serve as a safe store of value, so they have a high demand in the industry. Thanks to their role in the industry, depositing them in a savings account at a company like Cabital can net you an interest rate almost ten times as high as in banks with minimal risk.

Bitcoin and Ether

Bitcoin and Ether are the world’s largest cryptocurrencies in terms of market cap, with the latter initially devised as an improvement over the former. As part of a cryptocurrency portfolio, their features are as follows:

  1. Bitcoin and Ether can be volatile therefore they entail higher risks but also greater rewards
  2. Over the long term, their prices have been dramatically fluctuating but also growing.
  3. Putting them in a savings account returns a lower interest than stablecoins but higher than just HODLing over mid-term.

You would also want to dedicate a part of your crypto portfolio to these coins, especially since the value of most cryptocurrencies (except stablecoins) are positively correlated with bitcoin’s price movement. After all, even if you can only afford to invest in 0.005 of bitcoin, there’s a good chance it will prove more valuable than owning hundreds of tokens of a cheap coin. 

Tokens

Tokens are a type of cryptocurrency. They exist on the same blockchain as their mother cryptocurrency, but, unlike it, they are issued by a specific company or project for fundraising or governance. Historically, most tokens (though not all) are versions of ETH and circulate on Ethereum’s blockchain. Here are some important features of tokens one should keep in mind while you build or manage a crypto portfolio:

  1. As tokens represent a specific company or project, investing in them implies trust in the company in question.
  2. A token’s performance usually mimics the performance of its issuer, thus effectively making the tokens function as shares (which caused lots of regulatory problems to the issuers back in the day).

Regulated tokens are generally safer yet less profitable, and vice versa. Typically, a token is a riskier asset than a traditional cryptocurrency or stablecoin, as the value can tank during a crypto market downturn. Some savings platforms offer high APY through their platform token. These tokens can expose users to extreme volatility during the downtrend, where the promised yield generated won’t make up for the decrease in value.

Comparison of stablecoins, Bitcoin, Ethereum, and tokens in terms of investment efficiency
Table 2. Comparison of stablecoins, BTC, ETH and tokens in terms of investment efficiency

To minimise our investors’ exposure to risk, Cabital offers returns paid in in-kind currency. So if you invest in USDT, your returns will be in USDT (and likewise in the case of BTC and ETH).

Dollar-Cost Averaging

Another important technique for asset allocation in crypto is dollar-cost averaging (DCA). It means that you patiently buy out portions of the asset of your interest over a span of time instead of buying the total amount at once. This way, as you have purchased parts of the resulting amount at different prices, the overall cost averages itself out, and asset price fluctuations have a smaller effect on your portfolio. 

This strategy works well with traditional assets and crypto, the only difference being the fact that prices in crypto vary over time to a far greater extent than those in the world of regular shares or bonds. As a result, pros and cons to this strategy manifest themselves in crypto way more vividly than in traditional finance.

The pros of DCA include:

  • Hedging against moderate price fluctuations
  • Generally a safer way to benefit from the market in the long run

The cons, on the other hand, are as follows:

  • The strategy may cause one to miss out on a giant gain
  • In case of dramatic price fluctuations, hedging may become less efficient
  • Network fees may consume your interest earned, so keep that in mind when planning your DCA purchases 

Just as with any other investment strategy, this one is good when used in moderation.

How to Track Crypto Portfolio Performance With Cabital

If all those techniques and details seem a bit overwhelming, especially if you are new to crypto, fear not. Unlike other crypto apps, Cabital has a crypto portfolio tracker function that offers a simple way to track the dollar value of your investments without the need to download yet another app. By being able to see your P&L within the app, you’ll always know how much you’re earning on your crypto investments and whether you need to rebalance your portfolio to achieve your targets.

This article has been prepared by Cabital Fintech (LT) UAB  (the “Company”) and is general background information about some of the Company’s activities at the date of this presentation.

This article does not contain all the information that is or may be material to you and should not be considered as advice or a recommendation to you in respect of the holding, purchasing or selling of digital assets and does not take into account your particular objectives, financial situation or needs. This article has been made to you solely for information purposes. This presentation may be amended and supplemented as the Company sees fit, may not be relied upon for the purpose of entering into any transaction and should not be construed as, nor be relied on in connection with, any offer or invitation to purchase or subscribe for, underwrite or otherwise acquire, hold or dispose of any digital assets, and shall not be regarded as a recommendation in relation to any such transaction whatsoever. The contents of this presentation should not be considered to be legal, tax, investment or other advice, and you  should consult with your own counsel and advisers as to all legal, tax, regulatory, financial and related matters concerning an investment in or a disposal of such digital assets and as to their suitability for you.

This presentation and its contents are proprietary to the Company, and no part of it or its subject matter may be reproduced, redistributed, passed on, or the contents otherwise divulged, directly or indirectly, to any other person (excluding the relevant person’s professional advisers) or published in whole or in part for any purpose without the prior written consent of the Company.

This article contains forward‐looking statements. Such forward‐looking statements involve known and unknown risks, uncertainties and other important factors. Certain forward‐looking statements are based on assumptions or future events which may not prove to be accurate, and no reliance whatsoever should be placed on any forward-looking statements in this article.

The information in this article has not been independently verified. No representation or warranty, express or implied, is made as to the fairness, accuracy or completeness of the presentation and the information contained herein and no reliance should be placed on it. Information in this article (including market data and statistical information) has been obtained from various sources (including third party sources) and the Company does not guarantee the accuracy or completeness of such information. 

Further Readings

No items found.