Crypto Assets Diversification - Crypto Academy / S4W4 - Homework Post for @fredquantum

Question 1 - Explain Crypto Assets Diversification

Crypto assets diversification is a very popular strategy in the cryptocurrency space. When it comes to cryptocurrency investment, diversification is very important and can not only help reduce risk and losses of capital but can also help maximize profit. Every investor wants to make more profit that is why asset diversification has remained one of the most effective strategies used to minimize risk and also maximize profits. Crypto Assets Diversification is basically a risk management strategy or an investment strategy in which an investor splits his investment capital into multiple parts and diversify the parts into different assets.

When it comes to cryptocurrency investment, smart investors use this strategy of segmenting the investment capital into multiple parts and investing only with one part on a particular cryptocurrency asset to minimize risk and also maximize profit. The cryptocurrency market is known for its volatility and in the crypto market, anything can happen. Sentiments, negative news, and other factors can have a negative impact on the market which can go against any expert technical analysis. An investor can lose all his investment capital if he puts all his capital in a single asset if the market goes against his forecast. Also, an investor can miss other great opportunities because of investing all the capital on a single asset. Crypto asset diversification helps prevent this as the investor would divide the investment capital into smaller parts and invests only one part into an asset.

For instance, an investor has an investment capital of $300, instead of investing the whole capital on a single crypto asset, the investor decides to make use of the asset diversification strategy by splitting the capital into 4 parts of $75 each and invests each $75 capital on 4 different crypto assets. This is a great risk management and investment strategy because the possibility of the value of all 4 different assets crashing is very low, even if the value of one asset crashes, the investor would only lose $75 and there are 3 more assets that can make up for the loss. Also, there is a possibility that the value of one asset in the portfolio can skyrocket, putting the overall investment in profit. That is why crypto asset diversification is still one of the most effective and trusted risk management and investment strategies.

Question 2 - What are the Benefits/effects of diversifying one's assets?

Benefits of diversifying crypto assets

Crypto asset diversification is a very powerful and effective investment strategy that provides a lot of benefits. Some of the benefits of diversifying crypto assets are;

Minimizing risk

This is one of the benefits of diversifying crypto assets when it comes to investments. Asset diversification helps to minimize risk and prevent complete loss of investment capital. The crypto market is known for its volatility and also, anything can happen in the crypto space and the market can still go against any form of analysis. By diversifying crypto assets, it minimizes the incurred loss and prevents the investor from losing all the capital. For instance, an investor has an investment capital of $400, instead of investing the whole capital on a single crypto asset, the investor splits the capital into 4 parts of $100 each and invests each $100 capital on 4 different crypto assets. Even if the value of one asset from the portfolio falls drastically, the investor would not lose all his capital and would only lose $100 which is quarter of the investment capital while still having $300 worth of assets left.

Can lead to increased profit

Diversification of crypto assets has proven to also lead to increased profit. This is because an investor who has done proper fundamental and technical analysis and have chosen the right assets can make gains from all the assets in the portfolio. For instance, an investor invests $50 each on 4 different crypto assets, asset1 can have a 20% increase in price, asset2 can have a 50% increase in price, asset3 can have a 10% increase and asset4 can have a 30% increase. We can see that overall, the portfolio has made about 110% price increase. Imagine that the investor invested the whole $200 in asset1, that is just a 20% profit, which is still not up to the 110% profit made from the diversification.

Capitalizing on investment opportunities

Diversifying crypto assets can helps an investor capitalize on investment opportunities because it gives the investor more chances of acquiring more assets. Because of the volatility in the crypto market, it means that any asset can skyrocket in price that is why diversification is key. For instance, an investor who uses a $500 capital and invests it in 5 different assets of $100 each, depending on the portfolio construction, there is a possibility that one of the assets in the portfolio would 5x, 10x, 100x or even more, putting the overall investment portfolio in serious profit. This might not have been possible if the investor had invested the whole $500 capital on just one asset.

Effects diversifying crypto assets

While there are benefits in diversifying crypto assets, there are also effects. Some of the effects of diversifying crypto assets are;

Can lead to lower profit margin

This is one of the effects of crypto asset diversification as it can lead to lower profit margin compared to investing all the capital into one asset. For instance, an investor decides to split his $400 investment capital into 4 parts and invests each $100 into 4 different crypto assets ETH, DOT, LTC and SOL. After a period of time, one of the assets (SOL) in the portfolio increased by 10x, the investor would only make 10x of $100. The investor would have made 10x of $400 if he had invested $400 into SOL only.

Can lead to increase in overall investment cost due to transaction fees

This is another effect of diversification and investing in multiple assets. The transaction fees on some blockchain networks are high. Also, a lot of the top crypto exchanges charge fees for performing transactions such as trading and withdrawals, which increases the overall investment cost. For instance, an investor who has $500 and wants to invest $100 each on 5 different crypto assets, depending on the selected assets, the investor would have to pay network transaction fees or pay exchange fees for each of the selected crypto assets. The transaction fees for all the assets becomes higher than investing in only one asset.

Question 3 - Construct Crypto Assets Diversification according to the 1 - 4 Rule - Choose 4 crypto asset

For the construction of my crypto asset diversification, I will be using the 1-4 rule with an investment capital of $60 and fundamental analysis. This means that I will be investing $15 each on the different cryptocurrency assets. The coins cryptocurrencies I will be investing in are; BTC, DOT, MATIC and OKB. For me, when it comes to diversification of cryptocurrency assets, my strategy is to include large market cap coins, mid market cap and low market cap. I like to have the majority of large market cap coins in my portfolio as they are the less risky investments. Since I will be using the 1-4 rule, I will include 2 large market cap coins, 1 mid market cap coin and 1 low market cap coin.

• Large market cap - BTC, DOT
• Mid market cap - MATIC
• Low market cap - OKB

Bitcoin BTC

BTC is the first on my list because it is the largest cryptocurrency by market cap and the second largest by 24hr volume. Bitcoin needs no introduction as it is without a doubt the most popular cryptocurrency in existence and has become a household name for cryptocurrency in general in some less exposed parts of the world. Bitcoin BTC is basically a digital currency that was created to disrupt and provide solution to the conventional centralized financial system and allow anyone to send money via the internet to any parts of the world faster through peer-to-peer without the interference of any third party.

Bitcoin is decentralized and an open-sourced, which means that that anyone can contribute to the network. Also, transactions on the bitcoin network is transparent and anyone can have access to the transaction details. The main fundamental of bitcoin is that it is the biggest cryptocurrency in existence in terms of value. Bitcoin has a lot of use cases and in recent news, El Salvador’s adopts bitcoin as legal tender. History has proven that bitcoin has never been on the losing side in terms of its value and has always surpassed its previous all-time high.

Bitcoin – Social Reach/Popularity

Bitcoin is the biggest and largest cryptocurrency in existence and is regarded as the king of all cryptocurrencies. As far as social reach is concerned, bitcoin has the most social reach out of any cryptocurrency and is the most popular. Bitcoin is so big that El Salvador’s adopted bitcoin as legal tender. Anyone who know about cryptocurrency most likely know about bitcoin, making bitcoin the most popular cryptocurrency. BTC is listed on all the top crypto exchanges.

Purpose

The main purpose of Bitcoin is basically as a digital currency that created to disrupt and provide solution to the conventional centralized financial system and allow anyone to send money via the internet to any parts of the world faster through peer-to-peer without the interference of any third party.

Bitcoin BTC Statistics

Market capitalization - $776,604,878,804
Fully Diluted Market Cap - $865,006,936,593
Circulating Supply - 18,829,718.00 BTC
Total supply - 18,829,718 BTC
Max Supply - 21,000,000 BTC
24hr Volume - $30,266,272,512
All Time High - $64,863.10
Current Price - $41,194.87

Polkadot DOT

DOT is one of the top cryptocurrencies by market cap and is currently ranked 9th on coinmarketcap. Polkadot is one of ethereum’s major competitors and was created to solve some of the problems of the ethereum blockchain. Polkadot is a blockchain protocol that allows the connection of multiple blockchain networks into a one single network and is building solutions for Web 3.0. The main focus of the Polkadot ecosystem is scalability, security, and innovative solutions, allowing cross-chain applications to be built on it. The key features of Polkadot are;

Security,
Interoperability,
Scalability,
Easy blockchain innovation,
User-driven network governance,
Forkless and future-proof.
With the powerful features and use cases of Polkadot, there is a lot of growth potential for DOT.

Polkadot – Social Reach/Popularity

Polkadot has a very large social reach with millions of members in the community. It has a large twitter following with over 655k followers. Polkadot is seated at number 9 on coinmarketcap which means that it has a lot of exposure. Polkadot has a large community and at the moment, there are a lot of projects that are built on the Polkadot network. DOT is listed on a lot of the top crypto exchanges with high liquidity and volume.

Purpose

The main purpose of Polkadot is basically to provide solutions to blockchain by focusing on scalability, security, Interoperability, Easy blockchain innovation, User-driven network governance, Forkless and future-proof. Also, Polkadot was created as a protocol that allows the connection of multiple blockchain networks into a one single network, building solutions for Web 3.0 and allowing the building of cross-chain applications.

Polkadot DOT Statistics

Market capitalization - $26,709,048,280
Fully Diluted Market Cap - $29,617,313,600
Circulating Supply - 987,579,314.96 DOT
Total supply - 1,103,303,471 DOT
24hr Volume - $1,566,896,160
All Time High - $49.69
Current Price - $27.04

Polygon MATIC

Polygon is another very popular blockchain and cryptocurrency project at the moment and is ranked 21 on coinmarketcap, with a mid market cap. Polygon was created to provide solutions to ethereum scaling problems and for development of infrastructure. On the Polygon platform, the main component is the SDK that is basically a modular and flexible framework that provides the platform for the development of various applications. As a layer 2 scaling solution, Polygon aims to solve the scalability problems of many blockchain networks. The key features of Polygon are;

ETH Compatibility
Scalability
Security
Sovereignty
Interoperability
Modularity
User Experience
Developer Experience

Polygon – Social Reach/Popularity

Polygon MATIC has a very large social reach with millions of members in the polygon community. It has a large twitter following with over 700k followers. Polkadot is currently ranked number 21 on coinmarketcap gives it a lot of exposure and popularity. Polygon has a lot of use cases and is being used by many applications. MATIC is listed on a lot of the top crypto exchanges with high liquidity and volume.

Purpose

The main purpose of Polygon is basically to provide solutions to ethereum scaling problems and for development of infrastructure, and also as a layer 2 scaling solution, Polygon aims to solve the scalability problems of many blockchain networks and allows the connection of ethereum compactible blockchain networks.

Polygon MATIC Statistics

Market capitalization - $7,501,448,331
Fully Diluted Market Cap - $11,224,086,473
Circulating Supply - 6.67B MATIC
Total supply - 10,000,000,000 MATIC
Max supply - 10,000,000,000 MATIC
24hr Volume - $673,637,119
All Time High - $2.68
Current Price - $1.12

OKB OKB

This is the cryptocurrency that was released by OKex blockchain by the okex exchange, one of the largest crypto exchanges at the moment. It is not as popular as other exchange coins like BNB of Binance and KCS of Kucoin, but it has a lot of potential. It is a low market cap coin that is currently ranked 93 on coinmarketcap. OKB is very similar to BNB and BNB has shown that exchange coins can be successful with the right utility and use cases. The OKB coin serves as a utility token on the Okex ecosystem. OKB is used to pay for fees on the Okex exchange and also to have access to the special features and services of the Okex exchange. OKB is also used as a voting and governance token on the Okex platform. Also, holders of OKB receives rewards.

OKB – Social Reach/Popularity

Since OKB is the cryptocurrency of the Okex platform, it already has a very large exposure. Okex has thousands of users all over the world that are trading on the Okex exchange. Okex has a very large community on social media with over 540k followers on twitter. OKB is currently ranked number 93 on coinmarketcap which gives it a lot of exposure and popularity combined with the large community of the okex ecosystem. OKB has a lot of utility and use cases and is being used by many a lot of users. OKB is listed on the Okex exchange with high liquidity and volume.

Purpose

The main purpose of OKB is basically to serve as a utility token on the Okex ecosystem and to allow users to pay fees on the okex exchange and also reward holders of OKB.

OKB OKB Statistics

Market capitalization - $950,729,013
Fully Diluted Market Cap - $4,743,285,624
Circulating Supply - 60,000,000.00 OKB
Total supply - 300,000,000 OKB
24hr Volume - $469,497,198
All Time High - $44.17
Current Price - $15.88

Reasons why I chose these cryptocurrencies

They provide solutions - This is one thing I always look out for when investing in any cryptocurrency. I like to invest in coins that aims to solve problems and provide a lot of benefits. Bitcoin, Polkadot, Polygon and OKB all provide solutions with a lot of benefits.

They are all below their all-time highs - This is another factor for my decision. I like to invest in good coins that are below their all-time highs because it means that there is a big chance of making profits if the coin goes back to its all-time high and even surpass it. All the cryptocurrencies I selected are all below their all-time high prices.

They all have solid teams - This is another factor I look out for when performing my fundamental analysis. The team behind these cryptocurrencies are great, hence why these cryptocurrencies have a lot of growth and development potential.

Large community - This is another factor for my decision. These cryptocurrencies have a very large community on social media, BTC, DOT, MATIC, OKB have a very large community that makes it possible to gain more and more adoption and growth potential.

Process involved

For this process, I will be making use of the Okex exchange. For me, Okex exchange is one of the best crypto exchange and a top crypto exchange. Before I begin the investing process, I will first of all deposit some funds into the okex exchange account.

Clicked on assets and Selected deposit from the dropdown.

For this, I used the USDT option as it is very fast and has low transaction fees on the tron blockchain

After choosing the preferred network, I clicked on continue to proceed with the deposit.

Once the deposit is completed, it is time to purchase the assets.

At the top, click on markets

On the markets section, select from the list of available cryptocurrencies and click on trade to enter the exchange.

BTC/USDT

To purchase BTC on the BTC/USDT pair, click on "Buy" side

Select market section to buy at the current market price

Input the amount of USDT to purchase with. For me, I inputted 16 USDT

Activate the "take profit" and stop loss" option. For me, my Take Profit price was set at 50,000 and Stop Loss was 42,500.**

Click on Buy BTC to place the Buy order

DOT/USDT

To purchase DOT on the DOT/USDT pair, click on "Buy" side

Select market section to buy at the current market price

Input the amount of USDT to purchase with. For me, I inputted 16 USDT

Activate the "take profit" and stop loss". For me, my Take Profit price was set at 35 and Stop Loss was 26.50**

Click on Buy DOT to place the Buy order

MATIC/USDT

To purchase MATIC on the MATIC/USDT pair, click on "Buy" side

Select market section to buy at the current market price

Input the amount of USDT to purchase with. For me, I inputted 16 USDT

Activate the "take profit" and stop loss". For me, my Take Profit price was set at 2.2 and Stop Loss was 0.95.

Click on Buy MATIC to place the Buy order

OKB/USDT

To purchase OKBon the OKB/USDT pair, click on "Buy" side

Select market section to buy at the current market price

Input the amount of USDT to purchase with. For me, I inputted 16 USDT

Activate the "take profit" and stop loss". For me, my take profit price was set at 25 and stop loss was 14.50

Click on Buy BTC to place the Buy order

Order Details

Question 4 - Explain Arbitrage Trading in Cryptocurrency and its benefits

Arbitrage Trading is basically a type of trading opportunity in which a trader capitalizes on the price differences between two or more exchanges to make profit. In Arbitrage Trading, a trader buys a cryptocurrency asset on an exchange at a particular price and sells the same cryptocurrency asset on another exchange at a higher price to make profit with very minimal risk, or an investor buys a cryptocurrency asset on a particular cryptocurrency pair and sells the same cryptocurrency asset on another cryptocurrency pair to make profit.

This is common in the cryptocurrency space as sometimes the price of a particular cryptocurrency is higher on Okex than the price on Poloniex. when this arises, a trader can quickly buy the cryptocurrency at a cheaper price on poloniex and quickly sell it on Okex at the higher price to make quick profit. Also, Arbitrage Trading is also common on crypto pairs. Sometimes, the price on a particular cryptocurrency pair is much lower than the price on another cryptocurrency pair. A trader would capitalize on these price difference for quick profit while taking minimal risk.

When it comes to arbitrage trading in the crypto space, the two very common types are; exchange arbitrage trading and triangular arbitrage trading.

Exchange arbitrage trading

This type of arbitrage trading is very popular and is also seen in the crypto space. Exchange arbitrage trading is basically a trading that involves buying a particular cryptocurrency on a crypto exchange at a lower price, and selling the same cryptocurrency on another crypto exchange at a higher price. At the moment, there are numerous crypto exchanges which can sometimes have different prices between two or more. In exchange arbitrage trading, a trader spots the price differences between two exchanges and capitalizes on the price difference to make quick profit.

Triangular arbitrage trading

This type of arbitrage trading is also very popular and is also seen in the crypto space. Triangular arbitrage trading is basically a trading that involves capitalizing on the price differences between multiple crypto pairs. In triangular arbitrage trading, a trader sells a particular cryptocurrency for another cryptocurrency, sells that for another cryptocurrency and finally selling that cryptocurrency for the first cryptocurrency to make profits by having more quantity.

Benefits of Arbitrage Trading

Low-Risk - The risk level that is involved in Arbitrage Trading is very low that is why it considered as a very safe trading by a lot of traders. All the trader needs to do is to be quick enough to spot and capitalize on the price difference either on different exchanges or different crypto pairs, because the price differences might not last long if other traders discovers the opportunity too.

Quick profit - This is one of the main benefits of arbitrage trading. A trader can make quick profits if he is quick enough to capitalize on the price differences between two exchanges or two crypto pairs.

Question 5 - Discuss with illustration how to take advantage of Exchange Arbitrage

When there is an Exchange Arbitrage opportunity, a trader spots the price difference between two exchanges, the trader must be quick to capitalize on the opportunity to make quick profit. To demonstrate exchange arbitrage, I will be making use of an illustration to demonstrate how to capitalize on Exchange Arbitrage.

Let’s take for instance on Probit exchange, the price of MATIC on the USD pair is $1.02 and on Okex exchange, the price of MATIC on the USD pair is $1.18. A trader who is fast enough to spot the price difference between the two exchanges will quickly capitalize on the opportunity.

To illustrate this;

Price of MATIC on Probit Exchange - $1.02
Price of MATIC on Okex Exchange - $1.18

The trader Buys 5000 MATIC on probit exchange at the price of $1.02

5000 x 1.02 = $5,100 which is the cost of buying 5000 MATIC.

The trader quickly withdraws the 5000 MATIC to Okex exchange using exchange to exchange

The trader Sells the 5000 MATIC at the price of $1.18

5000 x 1.18 = $5,900 which is the value the trader gets after selling.

To get the profit the trader would do $5,900 - $5,100 = $800

From this, the trader has made an $800 profit.

Depending on the quantity of coins traded, even if trading fees and withdrawal fees are included, the trader will still be in profit.

Question 6 - Creatively discuss Triangular Arbitrage in Cryptocurrency. How to identify Triangular Arbitrage opportunities and the risks involved

Like the name triangular, it basically shows that there are 3 steps involved in the trading triangle. Triangular arbitrage trading involves capitalizing on the price differences between three cryptocurrencies pairs. In triangular arbitrage trading, a trader sells “cryptocurrency A” for “cryptocurrency B”, sells that “cryptocurrency B” for “cryptocurrency C” and finally sells that “cryptocurrency C” for the first “cryptocurrency A” to make profits by having more quantity. The trader can sell the extra coins to earn a profit.

[Design created by me]

From the illustration diagram, the trader already had MATIC coins. The trader discovered that there is a Triangular Arbitrage opportunity between the MATIC/ETH, BNB/ETH and MATIC/BNB pairs, so the trader capitalized on the opportunity.

Price of MATIC on the MATIC/ETH pair - 0.00037425 ETH
Price of BNB on the BNB/ETH pair - 0.1242 ETH
Price of MATIC on the MATIC/BNB pair - 0.002917 BNB

The trader already has 5000 MATIC

The trader sells 5000 MATIC for ETH at the price of 0.00037425 ETH.
The trader receives 1.871250 ETH

The trader sells 1.871250 ETH for BNB at the price of 0.1242 ETH.
The trader receives 15.0664 BNB

The trader sells 15.0664 BNB for MATIC at the price of 0.002917 BNB.
The trader receives 5,165.03 MATIC

To get the profit, 5,165.03 MATIC – 5000 MATIC = 165.03 MATIC

The trader has made a profit of 165.03 MATIC

Risk involved in Triangular Arbitrage

While the Triangular Arbitrage can be very profitable if done right, there are also some level of risk involved. Some of the risk involved in Triangular Arbitrage are;

Price Increase on the middle cryptocurrency pair

The cryptocurrency market is very volatile and anything can happen due to various factors. Since triangular arbitrage involves 3 cryptocurrency pairs, there is a risk of price of the middle cryptocurrency pair increasing against the first, causing the trader to have lesser quantity of the initial cryptocurrency. For instance, using my illustration above, the price of BNB/ETH increased to 0.1305 ETH which gives the trader 14.3390 BNB. After trading 14.3390 BNB to MATIC at the price of 0.002917 BNB on the BNB/MATIC pair, the trader receives 4,915.67 MATIC. This puts the trader at a loss of 84.33 MATIC.

Price slippage

This is one of the main risk involved in triangular arbitrage. Because of the volatility in the crypto space due to various factors, slippage can occur at any time. Slippage basically occurs when there is a quick change price between the price the trader is expecting and the market price. For instance, using the figures from my illustration above, the trader uses the market order type to sell 15.0664 BNB for MATIC at the market price of 0.002917 BNB. However, before execution, the a market price of MATIC on the MATIC/BNB pair changes to 0.003021 BNB and the sell order executes, 0.003021 BNB, which give the trader 4,987.22 MATIC. We can see that the trader has now made a loss of 5000 MATIC - 4,987.22 MATIC = 12.78 MATIC. The trader has now lost 12.78 MATIC on the triangular arbitrage.

Conclusion

When it comes to cryptocurrency investment, diversification is very important. It is a very effective risk management and investment strategy that can not only help reduce risk and losses of capital but can also help maximize profit. When it comes to cryptocurrency trading, Arbitrage trading has proven to be a very quick way for the quick and smart traders to capitalize on the price difference between two exchanges or multiple crypto pairs to make quick profits. However, while Arbitrage trading can be very profitable with minimal risk, there are also risk involved. That is why it is important for a trader to be very smart, careful and make the best decisions when venturing into arbitrage trading.