Bitcoin, altcoins, stable coins… How to Build a Crypto-Diversified Portfolio

Today, there are several thousand different cryptocurrencies. Only the two main virtual currencies, Ethereum and Bitcoin, account for 75% of the cryptocurrency industry, so the diversification in the cryptocurrency market has some features.

Analysis of the cryptocurrency market typology

The crypto market is a market dominated by Bitcoin and Ethereum. Today, the cryptocurrency market is really divided into small and large cryptocurrencies.

In fact, there are large, more liquid cryptocurrencies on the one hand, and smaller, less liquid and often riskier cryptocurrencies on the other. It is also important to distinguish between virtual currencies based on their size, features, volatility, efficiency, etc.

The state of the cryptocurrency market

As you can see from the chart above, the virtual currency market is a very concentrated market. Only the two leading cryptocurrencies – Bitcoin (BTC) and Ethereum (ETH), make up almost 75% of the total market, which is quite a lot. This extreme concentration is due to the interest of institutional investors and their ability to influence almost all market movements. All other virtual currencies account for less than 2% of the total market. Therefore, it seems obvious that the main market dynamics are determined by Bitcoin and Ethereum.

Cryptocurrency Typology in 2021

Cryptocurrency Typology in 2021

When choosing a cryptocurrency, it is important to distinguish between three main categories of cryptocurrencies. Each category is more or less risky, liquid, and viable over time. Thus, investment approaches differ if you want to invest in:

  • the largest cryptocurrencies (75% of the total market);
  • medium-sized cryptocurrencies (these are cryptocurrencies from 0.8% to 2% of the total capitalization, or 12% of the total market);
  • small cryptocurrencies (less than 0.8%, which is 14% of the total market).

At first, it seems preferable to follow the” whales ” of the market (holders of more than 1000 BTC) and, therefore, position yourself on the larger cryptocurrencies. Institutions that are very active in investing in Bitcoin and Ethereum have a great influence on the evolution of prices for large cryptocurrencies. Thus, BTC and Ether remain unstable, but their prices tend to be less hyped than the prices of most small cryptocurrencies.

Major cryptocurrencies benefit from significant institutional (and media) coverage. According to Glassnode, the number of whales (holders of more than 1,000 BTC or $ 50 million in Bitcoin in February 2021) increased by 27%, compared to 2020 (+ 13% in terms of capitalization). This shows the strong interest of large investors and organizations (less than 0.01% of the total number of users), which account for almost 32% of the total supply in 2020.

In addition, almost 97% of users hold less than 1 Bitcoin, but only own 5% of the total. This shows how strongly institutions influence the price of cryptocurrencies. Finally, we note the influence of trading platforms and miners. Exchanges and miners make up more than 22% of the total supply, while they make up less than 0.25% of Bitcoin holders.

It is obvious that institutions currently occupy a significant place in the market of the two main cryptocurrencies. This also helps explain the sharp rise in Bitcoin prices, as most demand from institutions is faced with less supply from individuals.

The presence of institutional investors provides a minimum of liquidity and prevents a complete collapse in prices. In addition, institutional investors react according to quite similar criteria, mainly global financial stress. Thus, there are correlations between large virtual currencies and financial markets. For example, a sharp drop in stocks can affect the virtual currency market.

Bitcoin attracts institutions with its quality of safe haven. There are many comparisons to gold. In addition, the greatest democratization has benefited the largest cryptocurrencies. The number of Bitcoin users increased from 35 million to 100 million between 2018 and 2020. This figure should exceed 200 million in the coming years, taking into account the investments made (PayPal, commercial banks, media coverage, Mastercard, etc.).

Small cryptocurrencies-altcoins

Small cryptocurrencies-altcoins

Some small virtual currencies outperform Bitcoin or Ethereum, and sometimes benefit from powerful catch-up effects. This is the case, for example, with Aave, Elrond, Cardano, etc. in recent months. Therefore, if the investor’s goal is to take advantage of general market fluctuations, it is best to focus 75% of the holdings on the first cryptocurrencies, and the rest on smaller virtual currencies.

However, one must be careful: the smallest caps (short-term prospects) in the crypto industry are unlikely to benefit from the safe haven that cryptocurrencies with the largest caps can have. And, of course, the risks are higher for small cryptocurrencies. Small cryptocurrencies are more prone to speculation, and serve more subtle purposes than, for example, Bitcoin. Bitcoin is not issued by a specific company and acts as a medium of exchange, which is not the case for all virtual currencies. Some cryptocurrencies are issued by companies and do not have the same features as BTC, for example, by the mode of operation, possible return, etc.

Also note that, unlike large cryptocurrencies, small capitalization (less than $ 1 billion) depends on the overall market dynamics and the success of the projects of the system or its associated company. Indeed, there are many small cryptocurrencies that have stagnated dramatically since their inception, and are struggling to achieve the desired success, which is not always a good sign. It is often better to bet on a small cap that appears or starts to create interesting market momentum (if you look at average monthly returns, fundamentals, media coverage, etc.).

Thus, in the context of a small cryptocurrency, we will mainly assess the seriousness of the project and its growth potential (the number of users, media enthusiasm, etc.).

Tips for Safe Investing

Tips for Safe Investing

However, not all cryptocurrencies are innovative, and face fierce competition from existing cryptocurrencies. So we should be wary of some very small and obscure investments.

Today, there are thousands of small virtual currencies. A very large number of them are tokens. A token is a cryptocurrency (digital asset) that grants certain rights (ownership, sometimes a refund, etc.), and can be transferred from one person to another without an intermediary. Tokens are often based on the Ethereum blockchain, which also explains the importance of Ethereum as a “key” for the cryptocurrency industry.

Tokens are often associated with companies that specialize in virtual currencies. That is, unlike Bitcoin or Ethereum, tokens have a private utility associated with a particular business. Companies that issue these tokens can choose certain characteristics: a token of utility, security, and reward. So we will distinguish some special characters that can be found on some tokens.

Some token-issuing companies ensure the regular destruction of some of the tokens in circulation. In theory, this allows you to create upward pressure on the price of these cryptocurrencies over time. This is, for example, the case with Binance Coin.

Some cryptocurrencies offer income in the same way that stocks pay dividends. This is, for example, the case of USD Coin ($6 billion capitalization) or even CHSB ($800 million capitalization in February 2021).

Often, more speculative and unstable tokens can offer very interesting growth potential. Some projects can democratize faster than the largest cryptocurrencies. This leads to a faster price increase for certain tokens. Media coverage of the project (in particular, Dogecoin by Elon Musk), its ability to attract new users, and the presence of weak competition in the same area of innovation are all advantages that are worth paying attention to over time.

Will stablecoins give stability to the crypto portfolio?

Some tokens tend to offer a stable price with low volatility. We are talking about stable coins-stablecoins. To ensure price stability, these crypto assets are linked to the underlying asset, like an ETF. Simply put, some stable coins simulate changes in assets, such as dollars, gold, etc.

For example, the Tether cryptocurrency is supported by the dollar, while DGX or PAX Gold are virtual currencies supported by the price of gold. For stable coins, the presence of underwriting remains the most common practice. However, there are other methods, such as changing the number of tokens in circulation in accordance with supply and demand, a guarantee system (for example, Dai, guaranteed by ETH).

Thus, stable coins are a way to mix cryptocurrencies and traditional assets in an investment portfolio, which can be considered as a useful tool for diversification. In a large crypto portfolio, stable coins are sometimes needed to reduce volatility and provide implicit diversification of assets such as gold, dollars, etc.

Stable coins perfectly prevent excessive volatility. In other words, stable coins by their structure represent an interesting alternative to limit the risks associated with the volatility of many cryptocurrencies, while simultaneously benefiting from the implicit impact on traditional assets.