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Should you put all your money into one type of crypto coin? Find out the difference between altcoins and bitcoin and how each can affect your portfolio.
Cryptocurrencies have skyrocketed in popularity over the last couple of years. While bitcoin remains the “king of the hill” of virtual coins, some other altcoins (smaller cryptos) are gaining traction and market value, driven by broader acceptance among retail and institutional investors.
As the concept of digital currencies works itself deeper into the mainstream, the conversation has evolved to an “altcoins versus bitcoin” debate and what to consider while building a crypto portfolio.
The cryptoverse is teeming with thousands of different digital coins, and new ones continue to roll off the assembly line. For the average investor, deciding which cryptocurrencies to pick could be tricky, and the intricacies are hard to grasp. On one end of the spectrum are blue-chip coins including bitcoin, ethereum and cardano. On the other end are the lesser-known coins of questionable utility and provenance, including meme cryptos such as dogecoin.
To help you make sense of these digital assets, MoneySense spoke to crypto experts about what to look for when building your portfolio.
Investors new to the crypto space need to evaluate if they want to focus on established cryptocurrencies or the newer, cutting-edge assets that potentially carry higher risk but can be substantially rewarding.
“The emerging assets don’t have the robustness and track record of the established assets like bitcoin and ethereum,” argues Brian Mosoff, chief executive officer of crypto-investment firm Ether Capital Corp.
While emerging assets may offer outsized returns, they may also be riskier to hold from a custodial perspective, he adds.
Currently, Canadian investors can gain exposure to assets like bitcoin and ether through structured products and ETFs, which removes the complexities of custody. This isn’t the case, though, with some newer assets requiring self-custody, which may not be advisable or feasible, Mosoff says.
Crypto newbies should do their due diligence and understand the risks around some altcoins—cryptocurrencies other than bitcoin—in the market.
Watch: Altcoins vs. Bitcoin
That depends on what you want in your crypto portfolio. Often, the bigger the reward, the greater the risk.
The key to creating a crypto portfolio is to invest in a diverse group of currencies so their performances are not closely correlated, says Jeremy Cheah, associate professor of crypto-finance and digital investment at Nottingham Business School.
The higher the correlation in the same direction, the higher the risk. “If you wish to minimize risk, then look for negatively correlated cryptos—that is, when the price of one crypto increases, the other falls to diversify away risks,” Cheah contends.
Diversification is as important in a crypto portfolio as it is in a traditional asset portfolio. “Going ‘all in’ on your favourite assets is generally not as safe or profitable as maintaining multiple types of products that can help hedge against each other,” says David Shafrir, chief executive officer at Secure Digital Markets, part of the GDA Group, a Canadian financial service provider for digital assets and one of the oldest and largest blockchain firms in North America.
Another thing to consider is whether you want to hold assets directly in cold storage (a digital wallet that is held offline) or on a crypto exchange, or you prefer to eliminate the custodial complexity by investing in a crypto ETF.
In the case of emerging coins, particularly, new investors must beware that “this technology is still in its early days, and new projects are absolutely at risk of bugs, hacks and thefts, which can very quickly erode an investment,” Mosoff warns.
As an asset class, cryptos are more volatile than traditional investments, but the fluctuations could be considerably more pronounced in smaller cap digital assets.“That works in both directions, so you may outperform bitcoin in a bull market but underperform it in a bear market,” says Mosoff.
The allocation of digital coins in your investment portfolio depends on where you fall on the risk tolerance spectrum—spanning from conservative to aggressive.
“Ultimately, each investor has to really decide for themselves what feels right, but broadly speaking, someone who is more conservative would want to have a fairly small portion of their portfolio in crypto,” says Shafrir.
A 5% or 10% allocation could still provide sizable gains over the years, while limiting exposure to the occasional 80% drop along the way, he adds.
Someone with a moderate risk tolerance could probably “withstand somewhere towards 20% to 50% in crypto, depending on what other risky assets they may be invested in,” says Shafrir.
As for the high-risk takers, Shafrir says “anything north of 50% will be exciting on good days, but they had better be prepared to weather the bad ones, too.”
In a broader, more balanced portfolio, cryptocurrency could serve as a risky but potentially very rewarding investment. Experts prescribe inclusion of more stable, safer assets, including different types of cryptocurrencies. For example, “investors can leverage stablecoins, which are cryptocurrencies pegged to traditional assets like the U.S. dollar,” Shafrir suggests.
While stablecoins provide no appreciation directly, they can be loaned out on various DeFi (decentralized finance) platforms for a decent and largely safe passive return, thereby offering increased diversity and more profit-making opportunities.
Crypto exposure also offers a potential hedge against inflation, and while all markets seemed to be correlated over the past year, that correlation could dissipate over time as “the asset class grows and continues to prove its robustness and acceptance by institutional investors,” Mosoff notes.
Moreover, cryptocurrencies are underpinned by a brand-new technology that many consider to be the next iteration of the web. And Mosoff points out: “People are really excited about the ability for value to move around the internet in a native way that does not rely on third parties, such as banks, to facilitate transactions.”
As with any asset class, there are risks associated with crypto investing. Historically, one of the biggest risks has been around custody. “In the early days, you saw a number of exchanges suffer from hacks or theft of funds without appropriate insurance or custody procedures in place, leaving investors without any compensation or recovery of those assets when something went wrong,” says Mosoff.
Investors who move assets offline to cold wallets must contend with managing the private keys—complex alphanumeric passwords needed to access their assets.
The recent crackdown on cryptocurrency mining and trading in China and the outright ban of crypto assets in several countries, show that regulations could be a significant source of risk.
Crypto investing also carries transaction risks—for example, mistakenly selling the wrong crypto, or sending crypto to the wrong person—that could lead to irreversible losses, says Cheah.
Other crypto risks include security breaches and the sudden shutdown of trading platforms. There have also been instances when millions of dollars were lost “due to programming risk such as bugs in some cryptos leading to liquidity being drained out from some smart contracts,” says Cheah.
As with any new technology, kinks will have to be ironed out over time, but some risks may have to be managed and mitigated with due diligence and common-sense practices.
The best hedges against volatility, for instance, are diversification and investing in safer assets. The risk of cybercrime can be mitigated by ensuring the brokerage or exchange has safeguards in place and has secured regulatory approval.
Investor education is the best tool for risk mitigation, Shafrir says. It’s essential to know how to safely buy, store and transfer crypto.
Bitcoin bias is an undeniable reality. There’s even a term for the dyed-in-the-wool bitcoin bulls, who tend to believe all other digital coins are doomed to fail—Bitcoin Maximalists.
“That is extremely short-sighted and misguided, because if you look at the amount of developer activity and usage happening on networks like ethereum, it’s foolish to ignore them,” saysMosoff.
Bitcoin competitors offer a different set of value propositions that have a legitimate place in the cryptocurrency space and in an investment portfolio, he adds.
It’s early days yet for crypto, and there will be new protocols and applications that disrupt or replace the ones that exist today. “It’s important to constantly be looking at developer activity as a bellwether for where the market may be in 12 to 36 months from now and use metrics like that to decide which assets to invest in,” says Mosoff.
Bitcoin has performed better than most other crypto coins over the last several years, but that certainly doesn’t make it the best, argues Shafrir. “There’s plenty that bitcoin can’t do on its own, like DeFi,” he says, but admits there’s “a strong case for having a large portion of your crypto portfolio in bitcoin.”
Given their asymmetrical returns, diversification benefit and growing adoption, cryptocurrencies merit a place in many portfolios. However, things are moving fast in the cryptosphere. A great new opportunity that doesn’t exist today could pop up in six months.
Alternatively, a cryptocurrency asset that seems like a winner today could have a critical flaw and fall out of favour tomorrow. Staying abreast of the latest news and developments is a big part of crypto investing.
And as with any risky investment, know your limit and stay within it.
Investors who want to get started on crypto can buy and hold bitcoin and other digital assets directly on local and foreign crypto exchanges. Canadian crypto trading platforms, including Newton, CoinSmart*, NDAX, Bitbuy and others, allow investors to buy, hold and sell bitcoin and a range of altcoins.
You can also own a large selection of cryptocurrencies through foreign-owned trading platforms—such as Crypto.com, Binance, Uphold and Kraken—that support multiple fiat currencies, including Canadian dollars.
This is a paid post that is informative but also may feature a client’s product or service. These posts are written, edited and produced by MoneySense with assigned freelancers.
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