Cryptocurrency has proven its appeal for those looking to test their risk appetite. Armed with the potential for high gains (or losses), the space has made it extremely easy for new users to get started.
Unlike traditional investments, which are cordoned by gatekeepers — asking for all sorts of KYC checks and income proofs — crypto invites everyone to participate. Today, buying Bitcoin is as easy as buying coffee from Starbucks; all it takes is a credit card.
This ease of entry has certainly played a role in crypto’s growing popularity. Between 2018 and 2021, the crypto user base has increased by over 500 per cent, and stands at more than 220 million people today.
“An increasing number of investors – individual and institutional – are open to having some crypto exposure in their portfolios,” explains Darius Liu, Group Chief Strategy Officer of Singaporean digital security exchange ADDX.
That being said, just because you can invest in crypto doesn’t necessarily mean that you should. Here are some key considerations to make when diversifying your portfolio.
Research your risks first
After reading headlines of overnight crypto millionaires, it can be tempting to buy into the first meme coin you come across. This wouldn’t be so much an investment as it would be a gamble.
Investors should be well-informed of the risks that come with the crypto market before putting any money in. Price volatility continues to be a risk factor, even as crypto stabilises as an asset class, and the investing world grapples with how best to value crypto assets.
There are also security risks. We read headlines about security breaches at crypto platforms that have led to significant losses.
– Darius Liu, Group Chief Strategy Officer of ADDX
Due diligence is crucial in this space, even more so now with over 10,000 crypto coins in existence. Everyday, there are new coins that promise the world — often with no plan of action other than tweeting at Elon Musk and hoping he makes them go viral.
“New investors should understand the value proposition of any coin they wish to trade, as well as the platform they are trading on,” says Liu.
Choosing an investment
For new investors, following the lead of professionals can be one of the safest options. This generally involves buying into large-cap coins such as Bitcoin and Ethereum, which are well-established and traded by institutional investors.
Investors, particularly retail investors, should not invest more than what they are prepared to lose, and never at the expense of other financial needs.
– Darius Liu, Group Chief Strategy Officer of ADDX
It’s also possible to gain exposure to these coins by investing in funds.
“To give just one example, the TCM Digital Asset Fund listed on ADDX provides investors with access to an underlying fund that has a portfolio with positions in Bitcoin and Ethereum, along with allocations in seven other coins,” says Liu.
Another popular choice are stablecoins such as Tether and USDC, which are also among the top cryptocurrencies by market cap. These have their value pegged to the US dollar, but currently offer much higher interest rates than banks do on the fiat currency.
Although they can make for relatively safe crypto investments, stablecoins come with accompanying risks too.
The risk associated with stablecoins stems from the opacity around whether they are well-backed by fiat currency assets. If a lot of people redeem their stablecoins at the same time, will the system be able to cope with those redemptions?
How can we be sure that stablecoins which claim to be fully-backed by underlying fiat reserves are actually backed in the way that they claim?
– Darius Liu, Group Chief Strategy Officer of ADDX
In 2019, Tether used to claim that each of its tokens were backed by US$1 held in traditional reserves. However, soon after, it was revealed that the reserves weren’t entirely comprised of cash. They comprised less liquid instruments such as loans receivables as well.
The importance of diversification
For those with access to traditional markets, the need to diversify into crypto might not be readily apparent. After all, if they wish to up their risk appetite, they can look into instruments such as stock options or futures contracts.
In such a scenario, the incentive to buy crypto might not come from its potential for high gains, but rather the protection it offers from traditional market cycles.
“Diversification helps to increase the robustness of a portfolio across different market scenarios, to the extent that the portfolio’s assets aren’t highly correlated with each other,” explains Liu.
“What is important is that investors have a good understanding of what they are buying, and they build a portfolio that is diversified across different assets – public stocks, private market stocks, bonds, real estate, and cryptocurrencies – and demonstrates resilience across market cycles.”
The emergence of NFTs
Over the past year and a half, crypto users have begun to explore the investment potential of NFTs as well.
There are projects which operate on revenue sharing models and offer passive income to NFT holders. Some are sustainably backed by established brands, while others share worrying resemblance to Ponzi schemes.
Liu believes that there’s still some time before the market forms a better understanding about the underlying value of NFTs. “It is not clear that they are well-established enough to be considered a mainstream investment. They are still relatively new, and not yet well understood by many investors.”
For those buying NFTs, perhaps it’d be best not to treat them as investments for now.
“The average NFT buyer should have, in mind, goals other than investment. For example, one may buy an NFT to appreciate it as a work of art in a personal collection, to show support for a particular cause or artist, or as a membership token for exclusive access to events and content,” says Liu.
“This ensures that even if the NFT doesn’t appreciate in price, the fundamental reason you bought the NFT remains valid.”
Featured Image Credit: ADDX