Diversification plays an important role in investing, even in the case of digital currencies. By holding a broad portfolio of different digital currencies, you may be able to add returns as well as reduce the single currency risk you would face if you only made a bitcoin investment.
When constructing a balanced digital currency portfolio, you need to be aware that while all digital currencies are high-risk investments, different digital currencies are riskier than others. Digital currencies can be put into three risk categories, which you can then use to determine how you want to structure your portfolio.
Digital Currency Risk Categories
- The “safest” digital currency that carries the lowest risk would be bitcoin. It is the most mature digital currency with the highest market capitalization. Bitcoin has grown into a viable alternative asset class in its eight years of existence, and even hedge funds are investing in bitcoin now. Given the size, liquidity, and popularity of Ethereum, you likely could also add its digital currency ether to the lower risk category.
- The mid-level risk category would be established altcoins such as Litecoin, DASH, Bitcoin Cash, Ripple or any other of the top 10 digital currencies that carry a market capitalization of over $1 billion. Investing in established altcoins is riskier than investing in bitcoin, but they could have more upside potential than their more mature “older brother” bitcoin.
- The riskiest category of digital currencies are the smaller, less established altcoins, which include newly issued digital currencies that have sprung out of recent initial coin offerings.
A balanced digital currency portfolio would imply a medium level of risk with strong returns potential. To keep the risk levels reduced, we will diversify our example portfolio to include primarily low-risk and medium-risk digital currencies and then we will add only a few high-risk holdings to increase expected returns.
An example of a balanced digital currency portfolio would be as follows:
- 40 percent Bitcoin
- 20 percent Ethereum
- 30 percent Established Altcoins
- 10 percent ICO Tokens/Smaller Altcoins
Bitcoin is the leading digital currency. That will likely remain the case for some time to come, as its ecosystem has grown into a multi-billion dollar industry and its adoption as an alternative digital currency as well as an investment is increasing daily. Therefore, it should make up a large chunk of your digital currency portfolio.
Ethereum is quite different from bitcoin in the sense that it is a platform for smart contracts and decentralized applications, which means its use cases go far beyond purely financial transactions. The Ethereum blockchain can be used to build a wide range of industry solutions, which is why the price of ether has increased so much in the past 12 years as more and more companies develop Ethereum-based business solutions. Hence, ether should also take up a high percentage of your overall holdings.
The established altcoins such as Ripple, DASH, Bitcoin Cash, Litecoin, Ether Classic, NEM, and Monero should make up about 30 percent of your holdings. These coins are less mature than bitcoin but offer valid solutions to their users, which might mean these digital currencies could outperform bitcoin over the coming years. However, they do carry a higher level of risk, which can be witnessed during market corrections. They tend to drop more than bitcoin when the market dips.
Finally, a small percentage of your balanced digital currency portfolio should be dedicated to ICO tokens and lesser-known altcoins. These are the high-risk plays that could pay off well in the coming years but could also drop in value without recovering. ICO token such as IOTA, OmiseGo, Qtum, and NEO, for example, all have interesting use cases and applications but are yet to prove themselves. Over the coming years, some will succeed and generate very high returns for their token holders while others will fail and cause losses for their holders.
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