Diversification Strategies in the Crypto Markets
In the past, we’ve talked about how cryptocurrencies can serve as diversification against the risks currently inherent in the rest of the economy, but what about diversification within crypto? How can we make sure to capture a lot of the “alpha” within the sector without diversifying out many of our returns?
These are questions we all have to come to our own conclusions on, but there are several approaches that can be taken, which will be detailed below.
The Silicon Valley Approach
It is often said that to achieve success as a venture capital investor in Silicon Valley doesn’t require you to only choose the right companies, it just means you need to not miss out on them. The gains investors would have made on Facebook or Paypal would more than cancel out hundreds of other investments. By understanding the power laws in effect, you can justify putting money into almost any project that seems feasible.
Just as the Dotcom boom had lots of overvalued projects (Pets.com), the ICO boom has projects that are in the mere contemplation phase, with a team lacking a track record. These companies may be avoided, but in general, you can be less selective on your investments and fund as many “altcoins” as possible.
This gives you an increasing number of chances to benefit from the insane returns achievable on investments like this. Bitcoin, even at the low price of $4500, has already gone through most of its gains, and is unlikely to achieve more than a 10x. But it started off being valued at less than a dollar, and you can benefit by finding the next Bitcoin.
Hedging within A Sector
Another approach that isn’t always possible in Silicon Valley is hedging an entire sector. If you see that there are a bunch of blockchain solutions in the insurance space, or real estate, or Internet of Blockchains, you have two possible routes. First, you can choose a “winner” and only put your money into that one. This is riskier, but will pay off more. Your other option is to buy all of the prominent companies in the sector. This allows you to hedge your bets, but reduces your profits.
What makes this sector-focused strategy appealing is that it benefits those who have gained specific knowledge in an area. In the venture capital space, it is not always permitted for you to invest in multiple companies in the same space, due to the influence these investors can have over management.
Blue Chip Investing Route
The final route you can consider is just continuing to dollar-cost average into the big boys (Ethereum, Bitcoin, Litecoin, Bitcoin Cash, Ripple). Think of this as indexing into the S&P 500. It is potentially the least risky of all these strategies, but obviously comes with its own potential downsides as well. There is always a chance that newer, more advanced, and better governed coins will oust all of the coins that are currently in the forefront of the space.
Many view Bitcoin as a hedge against other parts of your portfolio, but ignore the fact that Bitcoin could end up being the MySpace of the sector. Once you’ve considered the macro bet of going big on crypto, it is necessary to strategize within the space in order to minimize the unexpected risks. It is said that diversification is the only free lunch in financial markets, and this might apply extra in the crypto markets where you can get in so early.
Featured image courtesy of Shutterstock.
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