Diversifying digital assets: Purpose and principles of crypto portfolio allocation

In cryptocurrency's early days, buying Bitcoin (BTC) was the only way to enter the market. Today, it’s a different story. With the rise of blockchain technology and peer-to-peer (P2P) protocols, investors can choose from thousands of altcoins to diversify their wallets. The vast array of digital assets can be overwhelming, especially without a clear strategy for managing positions.

A well-planned crypto portfolio allocation provides traders with structured guidance, simplifying investment decisions and tracking progress toward their crypto and web3 goals. Beyond clarifying which assets to buy, having a set allocation strategy helps one manage the crypto market’s inherent volatility.

In this guide, we’ll explore crypto portfolio allocation and how understanding its basics can help traders effectively improve their returns.

What is crypto portfolio allocation?

Crypto portfolio allocation is a clear expression of how investors distribute their funds across various cryptocurrencies. Each digital asset in a trader's portfolio represents a specific percentage of the total account value. Combined, these percentages should equal 100% of the portfolio's worth.

In addition to defining the amount of each cryptocurrency in an account, portfolio allocation provides a framework for tracking growth and managing risk. Investors factor in personal criteria like time horizon, price outlook, and comfort with different assets when determining their preferred allocations. 

Once their preferred portfolio’s percentages are set, investors either buy their target cryptocurrencies outright or gradually build positions. They then monitor performance, adjusting assets as needed based on how each holds up against growth goals and risk preferences, buying or selling based on underperformance or outperformance.

Why does crypto portfolio allocation matter?

Using crypto portfolio allocation offers key benefits for managing risk and assessing the performance of a crypto investment strategy. Each digital asset in a portfolio has a unique volatility range and risk profile that influence the portfolio’s overall performance. Established cryptocurrencies like Bitcoin may offer lower risk and less volatility, while smaller altcoins carry higher potential for drastic price swings.

Traders can adjust risk levels by assigning specific percentages to different coins based on each asset's risk profile. This approach gives an objective framework for determining how much to invest in each project according to a preferred risk-to-return ratio.

Portfolio allocation percentages also make it easy to monitor each asset's strengths and weaknesses and decide when rebalancing is necessary. For instance, if a speculative cryptocurrency rapidly increases in value, its allocation could jump from 2% to 10% of the portfolio. The trader might then consider selling some of the position to lock in gains and restore balance. Regularly evaluating each asset in this context helps traders maximize gains, cut losses, and refine their approach according to personal financial goals.

Understanding crypto asset classes

When investors want to build their best crypto portfolio allocation, they often center their strategy on evaluating the risk each digital asset brings to their holdings. Categorizing cryptocurrencies based on risk profiles enables traders to better differentiate between the types of uncertainty tied to each asset.

Blue-chip cryptocurrencies

Similar to blue-chip stocks, blue-chip cryptocurrencies are digital assets known for their established records of stability, market resilience, and growth potential over the long term. While there are no guarantees these assets will always increase in value, blue-chip cryptocurrencies typically offer investors a stronger chance of favorable returns due to their industry reputation, robust networks, and high market caps. These “safer bet” projects generally avoid the extreme price swings seen with smaller tokens, instead presenting a lower-risk profile. Bitcoin (BTC) and Ethereum (ETH) are prime examples of blue-chip cryptocurrencies.

Mid-cap altcoins 

The term "mid-cap" typically refers to cryptocurrency projects with market capitalizations positioned between well-established blue-chip assets and smaller, speculative altcoins. While there’s no strict boundary, mid-cap altcoins generally fall within a market cap range of $1 billion to $20 billion. Many mid-cap cryptocurrencies have strong user bases, strong underlying technology, compelling use cases, and notable investor interest, though they carry a somewhat higher risk-to-return profile than blue-chip cryptocurrencies. Examples of mid-cap altcoins include Cardano (ADA), Solana (SOL), Chainlink (LINK), and Polkadot (DOT). 

Low-cap altcoins

The further a trader scrolls down a list of altcoins by market cap, the more they increase their risk exposure. Although these low-cap altcoins can deliver impressive percentage gains, they also carry a higher chance of sharp downturns and extreme volatility. Limited transparency on these assets further raises the likelihood of scams, such as rug pulls or pump-and-dump schemes. For traders interested in high-growth opportunities with altcoins, it’s important to account for the elevated risks these assets pose and to use robust risk management strategies.

Stablecoins

Traders who want to minimize exposure to volatility might allocate a portion of their portfolio to 'stablecoins.' These digital assets maintain a fixed 1:1 value relative to another currency or asset, typically pegged to the US dollar. While stablecoins lack growth potential, they provide a quick and effective way to secure gains, limit losses, or access income-generating opportunities within decentralized finance (DeFi). Popular stablecoins include Tether (USDT), USD Coin (USDC), and Dai (DAI). 

Building a diversified crypto portfolio: Crypto portfolio allocation examples

Everyone has unique views on specific projects and risk tolerance, making portfolio allocation a highly personalized strategy. Generally, those less comfortable with risk may allocate most or all of their funds to established blue-chip projects. As long as you understand the risk profiles of various cryptocurrencies and feel at ease with potential price fluctuations, there's no single "right" way to allocate funds.

For example, a conservative crypto portfolio allocation might include 60% Bitcoin, 30% Ethereum, and 10% in mid-caps like Chainlink, Polygon (MATIC), or Avalanche (AVAX). Conversely, traders seeking higher gains might allocate 30% to smaller, speculative projects while keeping 70% in Bitcoin for stability. 

It’s also possible to adjust allocations based on news, economic data, or changes in market sentiment. For instance, if the crypto market falls sharply and seems to be heading toward a winter phase, traders might increase holdings in large-cap projects and stablecoins to maintain stability. This flexibility makes portfolio allocation a dynamic tool for adapting to evolving market conditions.

Beyond crypto portfolio diversification: Complementary investment strategies

Crypto portfolio allocation defines how much capital to allocate to each digital asset but doesn’t dictate the steps to achieve or manage these goals. Investors can explore various methods to suit their investment preferences. 

• Lump-sum investing: The simplest approach to portfolio allocation, lump-sum investing involves buying the desired portions of each cryptocurrency in a single transaction. Proponents of this method value its ease and argue that “time in the market” is more beneficial than attempting to “time the market.” However, lump-sum investing can risk buying at a peak and requires having the full amount of capital available upfront.
• Dollar-cost averaging (DCA): The DCA strategy contrasts with lump-sum investing. It refers to an investor spreading purchases over time, allowing them to reduce the impact of market volatility. By regularly buying smaller amounts, DCA investors often achieve a more favorable average entry price. While DCA offers a gradual entry into the market, it also incurs higher fees due to the increased number of transactions.
• HODL: Derived from a typo on a Bitcoin forum, “HODL” has come to mean “Hold On For Dear Life.” This strategy focuses on long-term investment, often spanning years, with the expectation that market volatility will eventually favor patient holders. Those who HODL believe in the long-term value of digital assets and aim to ride out short-term price swings.
• Staking: For investors interested in earning passive income while holding, staking is an option. In networks using a proof-of-stake (PoS) model, participants lock (or “stake”) their crypto to validate transactions and secure the blockchain. In return, they receive token rewards. PoS blockchains like Ethereum and Solana (SOL) offer staking incentives, although this strategy involves risks, as the value of staked tokens can fluctuate. Staking can be done directly or through staking pools, providing rewards without relinquishing long-term positions.

Take control of your crypto portfolio with CoinTracker

As your crypto portfolio evolves, CoinTracker is here to help you keep tabs on your current crypto net worth. CoinTracker’s crypto portfolio tracker integrates with hundreds of exchanges, wallets, and DeFi platforms, giving you a complete and accurate view of your holdings. Beyond tracking, CoinTracker streamlines tax reporting by generating IRS-compliant forms that are ready to use with a CPA or software like TurboTax and H&R Block.

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Disclaimer: This post is informational only and is not intended as tax advice. For tax advice, please consult a tax professional.