Lessons Learned in Crypto Investing Part 2

Investing in the cryptocurrency market though rewarding is fraught with high amounts of risk. I would argue that investing in cryptocurrencies involves more risk than investing in the stock market because the price volatility of cryptocurrencies in much greater than the price volatility of stocks. Bitcoin, considered one of the more stable cryptocurrencies, experiences declines in value of 30% or more quite regularly. Recently we have seen this as Bitcoin reached a high of $19,000 US and has since declined to around $11,000 US, a decline of 37%. If a person invested all their long-term assets in Bitcoin at the high of $19,000 the drop that has since played out would be quite devastating and the investor would feel much anxiety. With investing I would suggest that investors employ strategies to mitigate such events so that the experience of investing is more comfortable and has more periods of positive outcomes than negative experiences.

I recently got excited about a particular coin, the coin Verge, as I became frustrated with the flaws of Bitcoin, its high transactions costs and slow processing time, and saw Verge growing in popularity because it doesn't have these flaws. The price of Verge was rising and given the huge opportunity I thought existed I ended up investing the majority of my cryptocurrency portfolio in Verge. My portfolio was concentrated in Verge for a few days, but I soon realized that I was taking on too much risk by concentrating my portfolio in one coin, no matter how huge the potential rewards could be. Verge at the time was trading around $0.20-0.25. Realizing my error in thinking I started selling my Verge until I actually held none of it anymore as I started to see that the coin is going to have more difficulty getting accepted than I originally thought. I built a new portfolio that is much more diversified investing in 11 coins with an overweight position in Vechain but a position that is not the majority of the portfolio.

It turned out that selling Verge was a good trade because the hype around the coin has died down and the price has fallen to $0.09 last time I checked. If I continued to hold most of my capital investing in cryptocurrenices in Verge I would have suffered a loss of 60% which would have been quite devastating. Given the high risk involved in investing in cryptocurrencies I think being diversified is a strategy we shouldn't take for granted and should try to employ all the time because we don't know the future and no matter how good the potential a coin may have, things can change, and given that many of these coins are not financially strong with high cash flows to back them up, the value can change dramatically. So unless you can stomach 60-80% losses easily I would try to stay diversified as much as one can.

The prices of cryptocurrencies are correlated so diversification can help but only to some degree. I have noticed that Bitcoin appears to be the price leader in that if it does well many of the altcoins follow and appreciate as well. The inverse is also true and I think the recent correction in altcoins has been the result of weakness in Bitcoin. So even diversification has not been able to prevent losses in the recent correction. Diversification enables an investor to mitigate single coin risk, such as the loss in a coin because it fails to grow it's user base or a coin falls in value because the time to process transactions slows down because it's network gets bogged down. Being diversified protects an investor from the risk of these single coin events.

Looking at an investor's whole financial picture they should usually be diversified among assets as well as being diversified within each asset. Unless the investors is comfortable having all their wealth invested in a group of assets that can decline by 80% thereby wiping out all their wealth it tends to be prudent to have one's invested capital invested in a variety of assets so as to have some invested in stocks, real estate, cryptocurrencies, cash, gold, and bonds and GICs. The benefits of investing in many different assets is that it protects the investor in the event that if any one of these assets declines severely the investor though impacted is not catastrophically impacted and will be more able to hold onto their assets and the one that has declined severely to benefit from it's subsequent recovery. If one is entirely invested in one type of asset and it suffers a severe drop they may be forced to sell that asset at the bottom for life reasons or because they can't handle such a severe loss and so they get out even if it is a bad time to sell.

They say diversification is the only free lunch in investing and this is so true. It doesn't cost us anything to be diversified and usually over the long run we get the same return as an investor who is more concentrated in their investments. The benefit of diversification is that the experience of investing is much more comfortable as the losses are less severe and so it helps investors take on more risk by investing in riskier types of assets allowing them to earn a higher return over the long-term as they have other assets to fall back on if the riskier investment suffers a severe decline in value. Good luck everyone and challenge yourself to see if you are diversified and if you would benefit from being more diversified.