Is It Smart to Diversify Your Investments in Cryptocurrencies?
Even your grandma knows you have to diversify your money into different things. But does she know Bitcoin, XRP and "Rainbow-banana-supercoin?"
“Never put all your eggs in one basket,” they say. “Smart people diversify their portfolio,” they say. “You can never know who the big winners will be, so you have to diversify,” they say. That all sounds like good advice. It was a sort of “it is known” matter-of-fact investment advice for most of my life.
But is diversification always smart?
The two investment spheres I know best are cryptocurrencies and the real estate sector. In either of those, diversification only makes sense under very specific circumstances.
For real estate, I would say it’s much wiser to stick to an area and type of real estate you know best.
That knowledge will ensure you make fewer purchasing mistakes. Since real estate is relatively illiquid and carries some taxation costs for most investors, it’s best to stick to what you understand. If you know your area, you can judge good opportunities better than somewhere you don’t know anything and rely on other people’s opinions. You will also have better access to opportunities and be able to react to them as they present themselves.
In rental property cases, you’ll also have a much easier job maintaining your properties and relationships with your tenants. Ideally, you would stack your rental properties as close to each other as possible. It would make your life a lot easier, and the potential dangers of doing that are minimal. Aside from extreme microeconomic changes and environmental catastrophes, I can’t think of anything substantial.
The world of cryptocurrencies is another interesting example.
Here, the problem isn’t so much managing your investment, although a more focused portfolio is easier to manage than a wildly diversified one. The problem lies in extreme correlation.
All cryptocurrencies are tightly attached to Bitcoins fait. Whatever happens to the big guy occurs to the small guys, only in a more volatile way. There is a little song-and-dance cycle sort of game going on, but for the most part, their fates are as intertwined as Siamese twins.
Here is the chart of Bitcoin.
And here is a chart of the total altcoin market cap, excluding Bitcoin.
Notice any similarities?
How about Ethereum, the golden goose that is supposed to dethrone Bitcoin?
I hear you, XRP army! Let’s look at that chart.
How about something silly, for example, DOGE?
As you can see, most of the time, Bitcoin and the vast majority of altcoins are inseparably correlated in large cycles. Diversification doesn’t add to the safety of your investments when they follow the same movements and are exposed to the same risks.
The problem lies in extreme correlation. All cryptocurrencies are attached to Bitcoins fait.
Since Bitcoin itself is monumentally safer to hold for a more extended period than some random basket of altcoins, it’s often simply better to play a Bitcoin-only focused game and add some leverage if you know what you’re doing!
We have to be honest with ourselves and admit that even the biggest, baddest cryptocurrency - Bitcoin - is still a risky investment.
It could go to zero one day for some unforeseen reason. It’s not very likely from my point of view, but the chances aren’t zero! Every year it survives, every FUD it overcomes, every attack it repeals, the stronger and safer it gets.
Listen, I am a big Bitcoin guy. Some would even call me a maximalist for some reason (totally clueless why), but if I had a lot of money, I would never expose all of it to Bitcoin!
With smaller amounts, I’m comfortable having most of my portfolio in Bitcoin for specific periods, especially during bull markets. The fear here is more price-oriented than existential. I am a trader, after all, not a hodler. But I wouldn’t sleep at night if I had something like 10 million in Bitcoin and there wasn’t at least as much lying around somewhere far away from this market.
Diversifying into altcoins adds more risk. It doesn’t alleviate it!
From the safety perspective, the only proper diversification is cash or outside investments. Real estate, cash, and Bitcoin are a nice combination for my personality.
I’ve extensively talked about my experiences and opinions on altcoins, so I won’t beat a dead horse here (here, here, here, and here). Suffice it to say, I’m not a fan of anything other than experimentation and short-time frame games.
It’s not wife material, but I might be down for a quicky in a bathroom, wearing double protection, even though I’ll feel dirty afterward. Literally and metaphorically.
That all takes into account my personal preferences and character, as I’ve already explained in other articles. What is right for me might not be right for you.
There is nothing wrong with trading or investing in altcoins. Just be careful and find your edge in the market. If you’re not actively scamming people, make some money, baby. Why the hell not? There is a lot of money to be made with all these little altcoins and whatever “new thing” of the season is (JPGs, DE-FI, ICOs…). I’m not saying there isn’t. It’s just not for me, that’s all.
So, is there never any case to be argued for diversification into altcoins?
No. Any portfolio should have some play money for riskier projects with ultra-high reward possibilities. So, for that small part of the portfolio, go wild. Just keep the investments small. If you hit a few 100x investments, even a tiny acquisition can bring big rewards. And because your investments were small, the potential reward might justify the extremely high risk that playing in that particular sandbox ensues.
For some, trading charts and Bitcoin will never present any allure. Some of you are better off scouring the earth for those small gems with high growth potential. However, I have no idea how you’ll find the diamonds among all the dirt. In this approach, when the goal is to get in at the beginning of a project’s life and ride the growth cycle as much as possible, diversification is fairly sensible simply because there is no tangible way of predicting what will work out in the long run.
Similar to investing in start-ups. You know most will fail, but some will make it big. You diversify and buy in early to ensure yourself a great entry price. Then you ride it out.
Owning one small shitcoin over another represents little difference in your risk-to-reward profile. But by holding 50 or 100, one might make it big one day. Considering tens of thousands of coins are out there, and we’re just getting started - good luck finding it. You’ll need it.
How about investing in cryptocurrency indexes?
I don’t mind that idea as long as you know this is not like buying an S&P 500 index but more of a gamble on the whole sector pumping like crazy. And pump it does. But usually only for a limited period before dying again and releasing most of the project into the afterlife.
Still, if your timing is good and you load up on a basket of crypto, representing the season’s winners, and you manage to get out before the fat lady stops singing, this could be well worth your time. Quite a lot of “ifs,” though.
My calculations have shown me that I’m better off just sticking to Bitcoin and playing it with some small leverage to keep it safe. Be wary of the third-party risk! FTX was the go-to for these indexes, and we all know how that ended.
I can’t help but think of altcoins only on a short to midterm basis because I believe that 99.9% of them will go to zero sooner rather than later.
And time has been proving me right thus far. However, there might be a few projects that will do phenomenally over a long time frame. I’m thinking in decades here. You know, the Googles, Instagrams, and Amazons of the altcoin world. Projects that will attract actual following and users in the billions - the few winners out of millions of failed attempts.
Thus far, I’ve seen nothing indicating any project besides Bitcoin that would have demonstrated anything remotely close to that real-life scenario or potential. Even the calamity that is Ethereum hasn’t shown that it can attract real-world usage on such a scale: only fun and games and a million new ways to lose money in the markets thus far.
So, should you diversify your portfolio in the cryptocurrency markets?
If you prefer to hope for 1000x winners and your investment window is measured in decades, then maybe. Just realize that there is no real diversification in crypto and that since the tide lifts all boats, it also lowers all boats at the end of the day.
Some crypto should definitely be a part of everyone’s investment portfolio, though. I would suggest Bitcoin, but “you do you.”
If you insist on diversifying, do it outside of crypto.
Whatever you do within this particular sandbox will most likely await the same fate. If you make some money in crypto, please move a large chunk of it out of the market for the love of God. Buy a home or some rental properties. Invest in stocks, bonds, gold, or whatever else. Even silly Lambos have been a better investment than most altcoins during the last couple of years. Stupid, yes, but at least they’re fun. Seeing your altcoin baggs sink deeper and deeper is anything but!
I have seen so many people become millionaires by being lucky and early in this space, only to see it all crumble into dust with a track record of -95% on their portfolio. Do better, friends.
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Stay safe out there.
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