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