Bitcoin, token, stablecoin...How to build a diversified crypto portfolio?

 To date, there are several thousand different cryptocurrencies. The top two virtual currencies, Ethereum and Bitcoin, alone account for 75% of the cryptocurrency industry. Diversification in the cryptocurrency market, therefore, has its peculiarities. Indeed, there are on the one hand the larger, more liquid cryptocurrencies and on the other hand smaller, less liquid, and often riskier cryptocurrencies. It is also important to distinguish between virtual currencies according to their size, their particularities, their volatility, performance, etc.

Discover in this article our analysis of the typology of the cryptocurrency market as well as the advantages and characteristics of the different types of virtual currencies, in order to determine which ones you want to invest in to build a crypto portfolio.

State of play of the crypto-currency market in 2022

Virtual currency: a market dominated by Bitcoin and Ethereum

To date, the cryptocurrency market is truly split between small and large cryptocurrencies.

As the chart above shows, the virtual currency market is a highly concentrated market. The top two cryptocurrencies Bitcoin (BTC) and Ethereum (ETH) alone account for nearly 75% of the total market, which is considerable. This extreme concentration is explained by institutional interest and its ability to influence almost all market movements. All other virtual currencies represent less than 2% of the total market. It, therefore, seems clear that the major market dynamics are defined by Bitcoin and Ethereum.

Typology of cryptocurrency in 2022

When choosing your cryptocurrencies, it is important to distinguish three main categories of cryptocurrencies. Each category is more or less risky, liquid, and sustainable over time. Thus, the investment approaches are different if you want to invest on:

  • the largest crypto-currencies (75% of the total market) ;
  • medium-sized crypto-currencies (these are crypto-currencies between 0.8% and 2% of the total capitalization, or 12% of the total market);
  • small crypto-currencies (less than 0.8%, representing 14% of the total market).

Bitcoin and Ethereum: what are the advantages of positioning yourself in the big cryptos?

Initially, it seems preferable to follow the "whales" of the market (holders of more than 1,000 BTC) and therefore position themselves on larger cryptocurrencies. Institutional investors, who are heavily invested in Bitcoin and Ethereum, have a major influence on the price evolution of the major crypto-currencies. As a result, Bitcoin and Ethereum remain volatile, but their prices are less volatile overall than most smaller cryptocurrencies.

This is because large cryptocurrencies receive a lot of institutional (and media) coverage. According to Glassnode, the number of whales (holders of more than 1,000 BTC, or $50M in Bitcoin as of February 2021) increased by 27% in 2020 (+13% in terms of capitalization). This shows the pronounced interest of large and institutional investors (less than 0.01% of total users), who account for nearly 32% of the total supply in 2020.

Furthermore, nearly 97% of users would hold less than 1 Bitcoin, but would only own 5% of the total supply. This shows the absolutely considerable power of institutional investors on the price of Bitcoin. Finally, we note the influence of exchange platforms and miners. Exchange platforms and miners account for more than 22% of the total supply, while they represent less than 0.25% of Bitcoin holders.

Clearly, it's the institutions that are making the market on the two major cryptocurrencies to date. This also helps to explain the sharp rise in the price of Bitcoin, with a majority demand from institutions and a minority supply from individuals.

The presence of institutional investors ensures a minimum of liquidity and prevents a complete collapse of prices. Moreover, institutional investors react according to fairly similar criteria, including mainly global financial stress. Thus, there are correlations between the major virtual currencies and the financial markets. For example, a sharp drop in stocks is likely to impact the virtual currency market.

Bitcoin attracts institutional investors as a safe haven. Comparisons with gold are numerous.

Furthermore, the largest cryptocurrencies are enjoying the greatest democratization. The number of Bitcoin users between 2018 and 2020 increased from 35 to 100 million. This figure is expected to exceed 200 million in the next few years given the investments made (PayPal, commercial banks, media coverage, Mastercard, etc.).

Read also:

Small cryptos: how to select emerging cryptocurrencies?

Some small virtual currencies are performing much better than Bitcoin or Ethereum and sometimes benefit from powerful catch-up effects. This is for example the case of Aave, Elrond, Cardano, etc. Therefore, if the investor's objective is to reproduce the overall market variations, then it is better to concentrate 75% of the assets on the first crypto-currencies and the rest on smaller virtual currencies.

Be careful though: the smallest caps in the crypto industry hardly benefit from the safe haven that the crypto-currencies with the largest caps can have. And naturally, the risks are higher on smaller cryptocurrencies. Smaller cryptocurrencies are more prone to speculation and serve more subtle purposes than Bitcoin, for example. Bitcoin is not issued by any particular company and acts as a medium of exchange, which is not the case with all virtual currencies. Some crypto-currencies are issued by companies and do not have the same characteristics as Bitcoin, for example, in the way they operate, their possible returns, etc.

Also note that, unlike large crypto-currencies, small caps (less than $1bn) are dependent on the overall market dynamics and the success of the associated system or company projects. Indeed, there are many small cryptocurrencies that have stagnated sharply since their inception and are struggling to find the expected success, which is not always a good sign. It is often better to bet on small caps that are emerging or starting to create interesting market momentum (look at average monthly performance, fundamentals, media coverage, etc.).

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

Aave: the small cryptocurrency with a lightning growth

For Aave, for example, its price went from $80 on January 1, 2021, to $480 6 weeks later, i.e. a 6-fold increase. This increase is almost entirely due to the intervention of many institutional investors. Aave is a project that appeared in 2017 and is now becoming a giant in decentralized finance. Aave allows users to receive interest on their deposits or borrow assets in a decentralized way. It is a new form of the financial system.

Nevertheless, not all crypto-currencies are innovative and face strong competition from established crypto-currencies. Therefore, one should be wary of some very small and obscure capitalizations.

Tokens: what's the point of investing in these digital tokens?

To date, there are thousands of small virtual currencies. A very large number are tokens. A token is a crypto-currency (a digital asset) that confers certain rights (ownership, returns sometimes, etc.) and can be exchanged from one individual to another without intermediaries. Tokens are often based on the Ethereum Blockchain, which also explains the importance of Ethereum, which appears as the "index" of the cryptocurrency industry.

Often, tokens are associated with companies that specialize in the virtual currency business. That is, unlike Bitcoin or Ethereum, tokens have a private utility, associated with a particular company. The companies issuing these tokens can decide on certain characteristics.

The burn

Some token-issuing companies ensure the regular destruction of a part of the token supply in circulation. This theoretically allows the establishment of upward pressure in time on the price of these cryptocurrencies. This is for example the case of the Binance Coin.

The yield, or return in French

Some cryptocurrencies offer yields in the same way that a share provides dividends. This is for example the case of the USD Coin ($6 billion capitalization) or the CHSB ($800 million capitalization in February 2021).

Often more speculative and volatile, tokens can offer very interesting growth potential. Some projects can democratize faster than larger cryptocurrencies. This results in a faster rise in the price of some tokens. The media coverage of a project (the example of Dogecoin by Elon Musk in particular), its ability to capture new users, and the presence of weak competition in the same field of innovation, are all advantages to watch over time.

Should you buy stable coins to bring stability to your crypto wallet?

Moreover, some tokens aim to offer a stable price with low volatility. These are called stablecoins. To ensure price stability, these cryptocurrencies are correlated to an underlying asset, much like an ETF. Put simply, some stable coins replicate the movements of assets such as the dollar, gold, etc.

For example, the cryptocurrency Tether is backed by the dollar while DGX or PAX Gold are virtual currencies backed by the price of gold. For stablecoins, the presence of an underlying asset is still the most common practice.  Other strategies exist, however, inclusive of converting the number of tokens in circulation according to supply and demand, a guarantee system (e.g. Dai guaranteed by ETH), etc.

Stablecoins are therefore a way to mix in one's portfolio of cryptocurrencies and traditional assets, which can be seen as a useful diversification tool. In a consistent crypto portfolio, stablecoins are sometimes necessary to reduce volatility and to ensure implicit diversification on assets such as gold, dollar, etc.

Stablecoins ideally help to avoid too much volatility. In other words, stablecoins, due to their structure, are an interesting alternative to limit the risks associated with the volatility of many cryptocurrencies, while benefiting from an implicit exposure to traditional assets.

All our information is, by nature, generic. It does not take into account your personal situation and does not constitute in any way personalized recommendations for the realization of transactions and cannot be assimilated to the provision of financial investment advice, nor to any incitement to buy or sell financial instruments. The reader is solely responsible for the use of the information provided, without any recourse against the publishing company of being possible. The publishing company of cannot be held responsible for any error, omission, or inappropriate investment.

Post a Comment