Beyond Bitcoin: Diversification Can Help Manage Crypto Risks
Andy RosenTue, November 30, 2021, 10:40 PM
This article provides information for educational purposes. NerdWallet does not offer advisory or brokerage services, nor does it recommend specific investments, including stocks, securities or cryptocurrencies.
When it comes to investing, diversification is key. By spreading your wealth around, you’re less likely to suffer a major financial blow should one of your investments not pan out.
This is especially true for cryptocurrency, an asset class so new and often volatile that some financial advisors caution their clients to steer clear of it.
Jesse Proudman, chief executive of the crypto investment platform Makara, says that people interested in buying cryptocurrency might learn from wealthy “angel” investors. These buyers, who fund early-stage startups, are used to dealing with projects that may or may not succeed.
“When you’re angel investing, you make a lot of different investments, and many of them fail, some of them are moderately successful, and some of them are incredibly successful,” Proudman said. “It’s that combination that makes your portfolio compelling. Diversifying here is smart for this same reason.”
But the novelty of crypto makes diversification more complicated than it would be for more traditional investments, such as stocks. For instance, there are no widely available mutual funds offering broad exposure to the digital asset space.
Still, there are some strategies savvy investors can use to mitigate their risks.
Buying a fund
There are relatively slim pickings for people of modest means who are looking for the simplicity of a professionally managed fund. But a handful of products have emerged that seek to make cryptocurrency more accessible to people most comfortable with traditional investing tools.
An exchange-traded fund, for instance, can be held in a brokerage account or used as part of a retirement fund, unlike crypto on its own. But such funds also carry fees, and they offer investors less control over their digital assets.
ETFs can be an easy way for investors to buy into diversified portfolios of stocks and other assets.
As it stands right now, though, the Securities and Exchange Commission hasn’t approved an ETF that would hold Bitcoin, nor any that invest directly in other digital assets.
One ETF option for crypto-curious investors is a fund that focuses on cryptocurrencies’ underlying “blockchain” technology. Such funds buy the stock of companies with an emphasis on that sector. Those, however, are not direct investments in cryptocurrency.
The lack of fund options available in the digital asset market is mainly due to the SEC’s skepticism.
Sarah Milby, senior policy manager at the Blockchain Association, an industry group, said it’s unlikely that broader-based funds will debut before U.S. regulators become more comfortable with cryptocurrency markets.
This fall, the first ETF linked to Bitcoin debuted on the New York Stock Exchange. But the fund doesn’t buy Bitcoin itself. Instead, it invests in futures contracts tied to the crypto asset.
Still, it’s a big step toward crypto becoming mainstream, and more ETF options could become available in the future.
Other funds have more direct exposure to multiple cryptocurrencies, but those have been restricted to private placement for accredited investors. Grayscale and Bitwise are among the financial firms that have created such products.
There are other ways for investors to get their hands on these products, as some of them have been listed on over-the-counter marketplaces. But investing through over-the-counter transactions, through which shareholders sell directly to one another, can come with fewer consumer protections than traditional, centralized exchanges such as the NYSE or Nasdaq.
Building your own portfolio
One disadvantage of funds is that investors don’t have direct ownership of their portfolios. For this reason, building a portfolio yourself can be appealing, especially when it comes to crypto, which may offer particular advantages.
For instance, crypto holders may want to participate in “staking,” a process available with some cryptocurrencies that reward participants for helping maintain the computer networks that support their tokens. Or they may simply want more control over their investment strategy.
Consult an advisor
Generally, cryptocurrencies are considered high-risk investments, which should make up only a small portion of your portfolio — one rule of thumb is no more than 10%.
For that reason, financial advisors often advise caution on crypto, and some shy away from making detailed recommendations for how to assemble a portfolio.
“Financial planners have not done a good job of being a part of this process,” said Justin Pullaro, a certified financial planner based in Florida who advises clients on cryptocurrency.
But as interest grows among clients, some advisors are beginning to offer more detailed recommendations. Pullaro said working with a professional can help potential investors feel more confident in their decision-making.
If you have a relationship with a planner, Pullaro recommended asking them about how they handle crypto. Or you can search online for planners and advisors who specialize in digital assets.
Explore online offerings
For people who don’t have a relationship with an advisor, some online offerings help people compose their crypto portfolios.
Though major online crypto exchanges such as Coinbase do not offer such services, new entrants in the field are attempting to fill the gap.
Makara, for instance, allows customers to choose among eight different “baskets” of crypto assets allocated for different goals. One, for example, includes top-valued “blue chip” cryptos, while another targets “Web3” projects that are focused on decentralized Internet technologies.
Do it yourself
One key trait of the up-and-coming generation of investors is increasing confidence in making independent investment decisions. This trend has fueled the ascendance of digital brokerages such as Robinhood, and it has been a defining feature of the crypto craze.
Online tools make it possible to assemble your portfolio easily, but they can require a level of digital savvy that not every prospective crypto investor has.
As a new asset class, cryptocurrencies do not have the same analytical tools as traditional investments such as stocks. And Proudman noted that even the publicly available information intended to educate people about crypto projects could be highly technical.
But there are some basic principles investors can follow if they are looking to begin constructing their portfolios.
Pullaro suggested using analytics websites such as CoinGecko, which provides basic market data, and CryptoMiso, which can help potential investors understand how the technology supported by a cryptocurrency is being used.
Pullaro said the crypto market “is growing rapidly in different directions,” and in ways that can be difficult to predict without significant amounts of research.
“If you don’t want to actively manage those positions and actively dig into the different projects, the next best thing you can do is own a broader basket of [investments] that can give you exposure to the entire space,” he said.
The author held no positions in the aforementioned securities or cryptocurrencies at the time of publication. NerdWallet is not recommending or advising readers to buy or sell any cryptocurrency.