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How To Build A Crypto Portfolio

November 7, 2022

On the surface, investing in crypto is a unique thing. The assets that you are buying are unique, for sure. They are not your run of the mill stocks and bonds that offer the prospect of dividend or interest income. Nor are they, in theory at least, hugely influenced by the economic health of one nation, and therefore by the actions of governments and central banks. For many investors those things are part of the appeal of crypto, but the uniqueness of cryptocurrencies as investments doesn’t mean that investing techniques and strategies that have been proven effective in other asset classes over time should be overlooked.

In fact, if anything, some of them are more important in crypto than anywhere else.

Handling Volatility

Crypto is a young market. Bitcoin, the first recognized and widely traded cryptocurrency, was launched by a white paper on October 31st, 2008, but didn’t really gain any traction until around four or five years later. So, crypto in general has only been around for less than a decade, and many of the popular tokens now a lot less than that. Markets that young usually have some defining characteristics. The most notable of those is volatility, and there has been no shortage of that in crypto over the last ten years!

Even though other, more established markets don’t usually experience volatility of the same intensity and duration of what we are currently seeing in crypto, many of the best-known investing techniques and strategies for things like stocks and bonds are designed to combat just that. The reason is simple. Volatility causes investors to make mistakes and bad decisions. If you are investing for your retirement in thirty or forty years, you shouldn’t care about a ten or twenty percent drop in what you own, but most of us still do.

We feel the urge to cut our losses in that situation, or certainly not to buy anything more, even though stocks or whatever are now “cheap” on a relative basis. As a result, we tend to sell at the bottom, and buy only at the top. You don’t have to be an investing genius or have an advanced finance degree from MIT to know that that isn’t a good idea!

Common Investing Mistakes & How to Avoid Them

There are basically two ways of avoiding the common mistakes made in that situation. You can reduce the impact of volatility on your portfolio in some way, making the urge to react less strong, and/or you can create a plan ahead of time that will allow for big swings. Of course, having a plan doesn’t mean that you will stick to it, but considering and planning for volatility before it comes makes it far more likely that you will. You can tell yourself “I knew this was coming, and prepared for it”, a surprisingly powerful mantra when faced with scary headlines about market moves.

Sensibly building a crypto portfolio involves using both techniques at once.

You can reduce the impact of volatility by diversifying your holdings. Don’t just buy BTC or ETH, for example, no matter how much you might think they reflect the whole market or are fundamental to the growth case for crypto, and certainly don’t put all your money in something like DOGE because its price doesn’t seem to be related to fundamentals at all. Doing that is more akin to trading than investing. Actually, as someone with forty years of trading experience I would say that it is not just trading, it is bad trading, but it certainly isn’t investing.

Trading is about seeking a quick profit. When I worked in a dealing room, my average position holding time was measured in minutes, and that average included some that I got stuck with all day when the marker barely moved, so many lasted only seconds. Investing, however, is about positioning your portfolio to slope gradually upwards over time, regardless of noise along the way. You aren’t looking to get rich overnight. You are looking to get comfortable over time, and to do that, you need to spread your risk.

Diversification

In traditional stock and bond investing, that means diversifying by buying both stocks, which go up when economic times are good and down when they are bad, and bonds, that generally move in the opposite directions, then also considering things like different industries and locations. That way you smooth out the bumps along the way. However, if you hold only stocks and bonds, your entire portfolio still reacts to economic conditions. You have diversity of assets, but not of influences. As we have seen recently with both stocks and bonds losing value as the Fed hikes rates, that isn’t always enough.

In the same way, a crypto portfolio that consists of just, say BTC, ETH and DOGE may look diversified, but really isn’t. Those are all assets that are influenced in the short-term primarily by the markets risk appetite. OG Bitcoin purists will tell you that BTC shouldn’t be correlated with stocks or anything, but whether they like it or not, right now bitcoin and most other cryptocurrencies are and, as a result, they move based on broad economic conditions and prospects. The trick when trying to diversify a crypto portfolio, then, is to find something whose value is not underpinned or directly a function of those same things.

Utility tokens can be an answer. Something like the SmartFI token, SMTF, that is underpinned by a loan portfolio that includes small business loans in the non-crypto world can help to diversify a crypto portfolio. A portion of the loans are on things like equipment and land and are therefore not necessarily subject to the vagaries of other crypto markets. The portfolio that SMTF represents has its own risks, of course, but they aren’t directly correlated to those in other crypto holdings.

Or you might want to look at one of the tokens tied to NFTs, like Tezos (XTZ), or an exchange like PancakeSwap (CAKE). If you want to diversify even more, consider a stock that represents the crypto world with broad crypto offerings rather than a token, like Coinbase (COIN), for example. The point is to diversify not just in terms of the names of coins or holdings, but also in terms of what they represent.

Averaging In

Even a diversified portfolio is still subject to the second problem, though, that of timing your investment. Do you buy on the way up, or wait for a dip? If the latter, at what point do you start buying? Should you sell at a certain level, either on the way up or down, and if so, what level should you pick? The problem with all of those questions is that the answers to them are usually based on an emotional response to market moves, and emotion is the enemy of good investing, and of good trading for that matter, too.

If you have a positive long-term view of something, then you don’t want your decisions to be based on emotion or short-term price fluctuations, no matter how smart you may be, or think you are. In that situation, you want to accumulate, regardless of price. That is the basis of a strategy known in the traditional investing world as Dollar cost averaging, or DCA.

The idea is simple. You spread your investment over time and allow the calendar, not the price, to dictate when you buy. You might, say, decide to invest $1,000 in each of three coins, but you do so by buying $100 worth of each on the first of the month or whenever best suits your cash flow for the next ten months. If the price rises during that time, you are happy because you bought some at a good price. If it falls, you are happy because now you are buying some at a discount. It creates an emotional win/win and ultimately results in a position at a decent average for long-term holding, or hodling if you prefer.

The point is that while most people think of crypto investing as something different, something that is apart from any other type of investing, the need for risk analysis and managing that risk where possible is still the same. Diversifying your portfolio and dollar cost averaging are techniques devised by conventional stock investors, but they can, and should, also be used to build a crypto portfolio.

Author: Martin Tillier
Martin has around forty years of market experience and, in addition to his role as Head of Research at SmartFi, is a daily contributor of market analysis and opinion to Nasdaq.com. He first became interested in crypto 2014, when he started writing regularly on the subject. He is from England but now lives in Connecticut, USA with his wife, his dogs, and his three kids’ college tuition bills. 
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