Interest in cryptocurrencies and digital tokens have peaked since the latter half of 2017. More people are curious about investing in digital currencies and Initial Coin Offerings (ICOs) but do not know how to build a complete cryptocurrency portfolio. The current market capitalization of all cryptocurrencies combined stands at $276 billion. The two most popular digital currencies Bitcoin (BTC) and Ethereum (ETH) have a combined market capitalization of $176 billion.
What does it take to build a winning crypto portfolio?
Benjamin Graham argued the need for rationale investment decisions and showed the difference between investing and speculating in his book The Intelligent Investor. Even 69 years after being first published, the book holds immense value and each word said by Graham is idolized by Wall Street investors and traders. It must be noted that most of the work done by Graham which contributed to the book began around 1928, just one year before the great depression. There was no proper financial analysis available which could be studied by investors before making any investment. After almost 90 years investors in the cryptocurrency industry find themselves in a similar place and most of them are speculating as to which digital token will be the next Ethereum or Bitcoin.
The basic investment ideology advocates that one should invest its money in assets that would grow at a faster rate than inflation. This basic concept holds true even when investing in digital currencies or tokens. People must not aim of achieving annualized returns of 40 to 60 percent on their investment in cryptocurrencies. Investors must always remember that they should only invest what they can afford to lose. Using house mortgage or credit card to buy digital currencies is not a smart investment idea. There are a few factors which investors must consider keeping in mind while building their crypto portfolio.
Volatility and Intrinsic Value
Cryptocurrencies and digital token industry is still in the nascent stage and hence they are prone to be more volatile than common stocks. Also it must be noted that cryptocurrencies can be traded every minute of the day and every day of the year. On the other hand stocks are traded only in trading hours on weekdays and also have a price limit or circuit. This circuit prevents the stock from making any major vertical or downward movements. However the lack of any such price limit in the cryptocurrency market is what makes it more volatile.
Investors can still use the volatility in the cryptocurrency market to their advantages. They can hold fiat in their wallets and begin buying cryptocurrencies when they are in a bear phase or undergoing a major correction. It has been observed that digital tokens which have been launched recently exhibit more volatility as compared to older tokens. This could be partly due to the fact that early investors who had purchased them in the pre stage or public sale are now selling their holdings.
Several ace Wall Street investors, analysts and bankers have repeatedly pointed out that cryptocurrencies lack intrinsic value. It is wrong to compare crypto with security as they both have differences. Volatility is not restricted to only cryptocurrencies. Two social media giants Facebook and Twitter both saw their shares plummet more than 20 percent in intraday trading after announcement of their quarterly results. Analysts were quick to label this as a selloff which would not change their long term positive outlook for both stocks. Investors who brought these shares at their lowest trading values in the session stand to gain more. Volatility in cryptocurrency also provides a great opportunity for investors to make new positions.
Diversification of portfolio
Merely buying cryptocurrencies does not count as having a crypto portfolio. A crypto portfolio must be diversified to include digital tokens and other crypto related financial products as well. Bitcoin is considered as the most safe bet among all cryptocurrencies and hence a significant percentage must be invested in the oldest cryptocurrency. In a typical traditional portfolio it was recommended that gold or other safe asset be allocated a small but significant holding to safeguard against downturns. In a cryptocurrency portfolio one may not be able to invest in government bonds or gold but Tether is the most stable digital currency. Every Tether is claimed to be backed by $1 and hence its value is always trading near the dollar mark. It can be said that Tether might be the safest bet in a downturn as each Tether is backed by fiat currency.
The Intelligent Investor classified investors in two types as aggressive investors and passive investors. Aggressive investors can devote a higher share of their assets in more risky investments while passive investors take a safer approach to investing. Bitcoin and Ethereum may be the two digital currencies which would be found in the portfolio of both aggressive and passive investors. Other digital currencies which would typically make the portfolio would depend on investor preferences.
Long Term Investor vs Short Term Investor
Any investor who is willing to hold digital currencies for a period greater than four years could be classified as a long term investor. Some definitions count investors with a seven year horizon as long term investors. It is also required for the investor to continue investing more capital at regular intervals. This helps the investor to make the most of any sudden downturns or sharp decrease in crypto prices. Most fortunes are built in a period when asset values have fallen and are redeemed when prices have escalated sharply and investor optimism is at an all time high. The trading price of any asset either in crypto or in securities is always directly proportional to the demand for it at any point of time. Investor optimism can sway crypto prices to new highs everyday while investor pessimism can result in a sharp decrease in trading value.
It must be noted that any temporary price fluctuation in prices of Bitcoin, Ethereum or any other cryptocurrency does not influence or affect their development. Investors should always have some liquid capital in their portfolio which should be used to exploit a dark swan opportunity. Short term investors should be watchful of cryptocurrency price cycles. Sticking to a buy low, sell high strategy could be the safest short term strategy but would be useless if either the bull or bear period extends for a longer time. Both short and long term investors must recognize that Bitcoin and Ethereum are digital currencies and not digital assets. Their value may grow substantially with time but currencies must be stable. When the crypto market would have saturated and most of the world’s population would have accepted using cryptocurrencies. Investing with a mindset to become an overnight millionaire is a wrong ideology and perhaps would do more harm than good.
Studying and Selecting Cryptocurrency
It is recommended that any investor take sufficient effort in studying a number of digital currencies in which he may be considering to invest. Studying the whitepaper of the cryptocurrency is a good way to begin the analysis. The whitepaper provides a great amount of knowledge and depth about the digital currency. Key points which must be read include the total supply and allocation of tokens. Some digital currencies can be mined while some are already mined when the mainnet is released. Bitcoin and Ethereum can be mined but Ripple tokens have already been mined.
The basic model and use case of the blockchain could also provide great insight in the future of the project. Bitcoin blockchain has been developed to process payments while it is also possible to run decentralized applications on Ethereum mainnet. Different blockchain projects have different applications and use cases. Some may be focused more on enterprise applications of blockchain technology while the rest may promise transactions with better privacy. Any investor must devote a large amount of his time before investing or acquiring any digital tokens.
Investing in ICOs
Initial Coin Offerings have become a preferred option for blockchain projects to raise capital for further development of their product or service. They offer digital tokens to investors. Tokens can be of two types either security tokens or utility tokens. Any investor must read the white paper of the project, research about the team and their experience besides trying to understand the use and future of the project. There seems to be lack of clarity on whether tokens sold in an ICO are counted as securities or not. Hence investors must be cautious and seek legal assistance if needed. A few ICOs may have been fake which were started by scammers to raise money from innocent investors. But most ICOs are being done by real teams working to develop blockchain based products. Whether the team can execute its promise and achieve scale depends on their efforts.
Thorough research must be undertaken before investing in an ICO and investors must never share the private keys of their crypto wallet at any stage of the sale process.
If you want to know more you can check our guide on How to analayse an Initial Coin Offering (ICO).
Ensuring security of digital tokens
A digital certificate of ownership is issued in the buyer’s name when he acquires shares of common stock from the exchange. But digital tokens are held in a cryptocurrency wallet and must be safeguarded sufficiently. Every cryptocurrency address has two set of keys, a public key which acts as the receiving address and a private key. The private key is needed to complete a fund transfer to another account. If the private key is lost then there is no existing way to retrieve it. Hence investors risk losing all their cryptocurrency holdings if they lose access to the private key. It is recommended that investors move all their tokens in an offline hardware wallet. These offline wallets are not connected to the internet and hence have far lesser probability of being targeted by attackers. Cryptocurrency exchanges and other online wallets also offer facilities for storing digital currencies of investors but they could be vulnerable to being hacked or attacked. But is it possible to end with hacks and attacks?
The above references an opinion and is for information purposes only. It is not intended to be investment advice. Seek a duly licensed professional for investment advice.