How Digital Currency Can Help Diversify Your Portfolio

Diversification has long since been a reliable friend of traders as a crucial step to spreading their risk.

Quite evidently, last year had taken digital currency on a turbulent ride. The sudden fall in the prices of cryptocurrencies owing to the negative macroeconomic environment and the FTX collapse clearly robbed digital currency enthusiasts of the long-term bullish sentiment. While people dived into panic selling, the uncertainty caused by its unregulated nature added to the bearish mood of active traders present in the digital currency market.

Even as some held high hopes for this financial asset, many of them opted to use it to diversify their portfolios. Diversification has long since been a reliable friend of traders as a crucial step to spreading their risk. Traditional asset allocation methods might benefit from portfolio diversification offered by cryptocurrencies. However, it is crucial to gauge the market sentiment before adding it to an investment portfolio, to leverage the volatility of this segment. With more than 21,000 cryptocurrencies present in total, the question we need to ask is which crypto is more reliable for portfolio diversification.

Bitcoin As A Potential Option

Investors looking to diversify their portfolios are increasingly turning to Bitcoin as a potential option. Bitcoin's unique features, including its low correlation with traditional financial assets, instability, and risk-reward profile, make it an attractive option for those seeking to reduce portfolio risk and capitalize on potential returns.

The low correlation of returns between Bitcoin and traditional assets such as stocks, bonds, and commodities is a key feature that provides portfolio diversification. This independence from other assets means that the performance of Bitcoin is not tied to that of other assets, making it an ideal candidate for investors looking to spread their investments across different asset classes. The substantial rise in the value of Bitcoin and other crypto coins during the start of 2023 was one such instance where experts believed that the down trail in digital currency prices will continue owing to the impending recession. However, as Bitcoin touched its 5-month high in January, the uptrend deviated from those predictions.

Save Your Analysis

Analyzing market movements is one of the primary keys to becoming a diligent market participant. Every step you take in the market must be carried out by a strong comprehensive analysis. Understanding market sentiment is crucial to take necessary steps as it assists you in making essential decisions before the market takes a downturn. However, it also means pouring your time into the constant analysis. Diversifying assists you by leveraging the low correlation between securities and digital currency, so there is a possibility that ‘everything won’t go down together’ except during black swan events.

Also, the lack of direct correlation between digital currency and traditional financial systems might make it an attractive option for investors, looking to reduce exposure to local market risks and gain exposure to a wider range of investment opportunities.

Explore The Market

While it is a common practice to invest in securities that are fundamentally and technically sound, investing small chunks of your money in unexplored parts of markets can help you in developing a better understanding of the same while providing the potential to leverage on any trends. This further assists you in better defining your long-term investment goals. 

Although precautions need to be maintained while stepping into new markets, it is advisable to start from a small amount for new market players. Eventually, as you will gather market insights, you would be better able to take meaningful investment decisions for your portfolio. Financial markets can vary in their degree of rules and regulations. Moreover, just as in any other market, a variety of factors can impact the price fluctuations of a particular asset, owing to diverse market sentiments present. To increase the profits on these assets, interested traders and investors might profit from these price fluctuations. But to cover up potential losses, diversification should be employed to a certain degree.

More The Diversification, The Better The Risk-Reward Profile

The growth of the Bitcoin market has also made it easier for investors to access and invest in Bitcoin as part of a diversified portfolio. The increased liquidity and investability of Bitcoin have attracted significant investment interest from both retail and institutional investors, making it a more attractive option for those seeking greater flexibility in portfolio management.

The risk-reward profile of Bitcoin is another feature that draws investors seeking diversification. Although Bitcoin is known for its high volatility, this volatility could also present more market opportunities for those willing to take on higher risks. 

By employing diversification in portfolio management, investors can reduce overall portfolio risk, gain exposure to a wider range of investment opportunities, and capitalize on the growth potential of this innovative digital currency. While the central thought behind diversification can also lower your return profile, it is crucial to be diligent about balancing your investment portfolio.

(The author is the Chief Strategy and Trading Officer at Vantage, a global multi-asset broker.)

Disclaimer: The opinions, beliefs, and views expressed by the various authors and forum participants on this website are personal and do not reflect the opinions, beliefs, and views of ABP Network Pvt. Ltd. Crypto products and NFTs are unregulated and can be highly risky. There may be no regulatory recourse for any loss from such transactions. Cryptocurrency is not a legal tender and is subject to market risks. Readers are advised to seek expert advice and read offer document(s) along with related important literature on the subject carefully before making any kind of investment whatsoever. Cryptocurrency market predictions are speculative and any investment made shall be at the sole cost and risk of the readers.