Return to site

Diversifying your crypto portfolio: a profile on alt coins and why you need them

Diversify, diversify, diversify!

What is diversification?

Diversification is an investing technique used to manage risk by mixing a wide variety of investments within a portfolio. The idea is that a portfolio constructed of different kinds of investments will, on average, yield higher returns and pose lower risk than any individual investment within a portfolio.

Diversification is used to smooth out unsystematic risk events in a portfolio so the positive performance of some investments offset the negative performance of others.The benefits only hold, though, if the assets in the portfolio are not perfectly correlated. This means that the price of the assets should not go hand-in-hand with the price of the other assets in the portfolio.

Generally, advisors say that maintaining a diversified portfolio of 25 to 30 stocks yield the most cost-effective level of risk reduction. However, not all investors work with large amounts of capital and income in order to invest in many stocks and bonds. This is why mutual funds, which are already diversified, have been increasing in popularity. Middle- and lower-income investors tend to buy shares of mutual funds because these provide investors with an inexpensive source of diversification. Investors with 401(k) plans and other retirement plans tend to have shares of mutual funds.

So, how do investors in the cryptocurrency market diversify their portfolio to ensure they are better hedged in the market? By investing in altcoins.

Altcoins

Altcoins are the alternative cryptocurrencies launched after the success of Bitcoin. Bitcoin paved the way for many alternative cryptos, as many are built on the same framework provided by Bitcoin. But, altcoins tend to target any perceived limitations of Bitcoins, marketing themselves as better substitutes because of their applicability and usage.

For example, Ether was designed as a token to use the Ether network in order to execute computer code, such as in a smart contract, and in such in a way that it would be verifiable what was executed on the Ether blockchain. Another altcoin, Ripple, was designed to enable "secure, instantly and nearly free global financial transactions of any size with no charge backs." It supports tokens representing fiat currency, cryptocurrency, commodity or any other unit of value such as frequent flier miles or mobile minutes.

Ripple CEO Brad Garlinghouse told Fortune in October, “You’re seeing vertical solutions where [Ripple] is focused on payment problems, Ethereum is focused on smart contacts, and increasingly Bitcoin is a store of value." These solutions are the result of altcoins and the innovation they provide in the market.

My Top 8 Altcoins

So, what are some altcoins you should take a look at when diversifying your crypto portfolio? Below are my top eight:

  • Ethereum. Ethereum is an open-source, public, blockchain-based distributed computing platform featuring smart contract (scripting) functionality. It provides a decentralized Turing-complete virtual machine, the Ethereum Virtual Machine (EVM), which can execute scripts using an international network of public nodes. Ethereum also provides a cryptocurrency token called "ether", which can be transferred between accounts and used to compensate participant nodes for computations performed
  • Ripple. Designed to enable "secure, instantly and nearly free global financial transactions of any size with no chargebacks." It supports tokens representing fiat currency, cryptocurrency, commodity or any other unit of value such as frequent flier miles or mobile minute
  • Litecoin. Litecoin was released via an open-source client on GitHub on October 7, 2011 by Charlie Lee, a former Google employee. It was a fork of the Bitcoin Core client, differing primarily by having a decreased block generation time (2.5 minutes) rather than Bitcoin's 10 minutes. The developers claim that this allows Litecoin to have faster transaction confirmation. Other differences include an increased maximum number of coins, different hashing algorithm (scrypt, instead of SHA-256), and a slightly modified graphical user interface (GUI).
  • IOTA. IOTA is a cryptocurrency focused on providing secure communications and payments between machines on the Internet of Things. Using directed acyclic graph (DAG) technology instead of the traditional blockchain, IOTA's transactions are free regardless of the size of the transaction, confirmation times are fast, the number of transactions the system can handle simultaneously is unlimited, and the system can easily scale. IOTA was founded in 2015 by David Sønstebø, Sergey Ivancheglo, Dominik Schiener, and Dr. Serguei Popov.
  • Dash. Dash is an open source peer-to-peer cryptocurrency. On top of Bitcoin's feature set, it currently offers instant transactions (InstantSend), private transactions (PrivateSend) and operates a self-governing and self-funding model that enables the Dash network to pay individuals and businesses to perform work that adds value to the network.
  • Monero. Monero uses a public ledger to record transactions while new units are created through a process called mining. Monero aims to improve on existing cryptocurrency design by obscuring sender, recipient and amount of every transaction made as well as making the mining process more egalitarian. Its privacy has attracted illicit use by people interested in circumventing the law. Researchers have reported that the operators behind the global ransomware incident WannaCry have converted their proceeds into Monero. It is also the preferred payment method of choice for The Shadow Brokers.
  • NEO. NEO runs its own blockchain, which improves on Ethereum’s algorithm, making it more efficient and secure. It aims at supporting a smart economy using digital identity technology to allow for the digitization of assets and, like Ethereum, supports smart contracts, which allow for the management of those same assets.
  • EOS. EOS runs its own blockchain architecture, designed to enable “vertical and horizontal scaling of decentralized applications”. This means that EOS’s system is designed to scale, is capable of supporting accounts, authentication, databases, asynchronous communication and any type of application on top of its blockchain, processing millions of transactions per second at nearly zero cost.
As always, you should look at coinmarketcap to get better insight into the prices of different cryptocurrencies out there, their market cap, and the trends they've been seeing. It is also a good idea to do research on the cryptos you are investing in and understand the value they offer to the community. If they offer great value, like Ethereum's smart contract ability, they may be a good investment. If not, and there seems to be a lack of investors behind the effort, along with no finished product, it may be best to avoid that crypto. It is important to avoid scams in any investment, including cryptos!

Correlation

It is important to know how cryptos correlate when looking to diversify your portfolio. The below table shows the correlations between various cryptocurrencies.

Comments:

  • The correlation closer to 1 mean that prices behave similar
  • The correlation closer to -1 means an inverse relationship, i.e prices move in different directions.
  • The correlation close to 0, means movements outweigh each other.

Another interesting trend is there exists positive correlation between the value, or market capitalization, of a cryptocurrency and the number of exchanges that it is listed on. For the top 1,000 cryptocurrencies, the correlation is over 50 percent. Rudimentary data analysis indicates that the market capitalization of the coin or token crudely increases with exchange listings. It is important to note, however, correlation is not causation and it is not wise to simply conclude that listing a cryptocurrency on more exchanges always adds more value to the cryptocurrency. For instance, Litecoin is listed on 94 exchanges compared to Bitcoin’s 88, yet Bitcoin is a magnitude larger in market capitalization.

Conclusion

Diversify, diversify, diversify! it is better to buy into multiple cryptos like Ether, Bitcoin, Ripple, and Litecoin, rather than just one. This ensures you’re better hedged in case the price of one begins to fall. Just make sure to avoid scams and alt coins that have no real value. You do not want to end up like the investors in Confido, which collected $374,000 in an ‘initial coin offering,' then collapsed.