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What to consider when building a crypto portfolio
That depends on what you want in your crypto portfolio. Often, the bigger the reward, the greater the risk.
The key to creating a crypto portfolio is to invest in a diverse group of currencies so their performances are not closely correlated, says Jeremy Cheah, associate professor of crypto-finance and digital investment at Nottingham Business School.
The higher the correlation in the same direction, the higher the risk. “If you wish to minimize risk, then look for negatively correlated cryptos—that is, when the price of one crypto increases, the other falls to diversify away risks,” Cheah contends.
Diversification is as important in a crypto portfolio as it is in a traditional asset portfolio. “Going ‘all in’ on your favourite assets is generally not as safe or profitable as maintaining multiple types of products that can help hedge against each other,” says David Shafrir, chief executive officer at Secure Digital Markets, part of the GDA Group, a Canadian financial service provider for digital assets and one of the oldest and largest blockchain firms in North America.
Another thing to consider is whether you want to hold assets directly in cold storage (a digital wallet that is held offline) or on a crypto exchange, or you prefer to eliminate the custodial complexity by investing in a crypto ETF.
In the case of emerging coins, particularly, new investors must beware that “this technology is still in its early days, and new projects are absolutely at risk of bugs, hacks and thefts, which can very quickly erode an investment,” Mosoff warns.
As an asset class, cryptos are more volatile than traditional investments, but the fluctuations could be considerably more pronounced in smaller cap digital assets.“That works in both directions, so you may outperform bitcoin in a bull market but underperform it in a bear market,” says Mosoff.
How much should I invest in crypto?
The allocation of digital coins in your investment portfolio depends on where you fall on the risk tolerance spectrum—spanning from conservative to aggressive.
“Ultimately, each investor has to really decide for themselves what feels right, but broadly speaking, someone who is more conservative would want to have a fairly small portion of their portfolio in crypto,” says Shafrir.
A 5% or 10% allocation could still provide sizable gains over the years, while limiting exposure to the occasional 80% drop along the way, he adds.
Someone with a moderate risk tolerance could probably “withstand somewhere towards 20% to 50% in crypto, depending on what other risky assets they may be invested in,” says Shafrir.
As for the high-risk takers, Shafrir says “anything north of 50% will be exciting on good days, but they had better be prepared to weather the bad ones, too.”
Does crypto belong in a balanced portfolio?
In a broader, more balanced portfolio, cryptocurrency could serve as a risky but potentially very rewarding investment. Experts prescribe inclusion of more stable, safer assets, including different types of cryptocurrencies. For example, “investors can leverage stablecoins, which are cryptocurrencies pegged to traditional assets like the U.S. dollar,” Shafrir suggests.
While stablecoins provide no appreciation directly, they can be loaned out on various DeFi (decentralized finance) platforms for a decent and largely safe passive return, thereby offering increased diversity and more profit-making opportunities.
Crypto exposure also offers a potential hedge against inflation, and while all markets seemed to be correlated over the past year, that correlation could dissipate over time as “the asset class grows and continues to prove its robustness and acceptance by institutional investors,” Mosoff notes.
