The concept of a balanced crypto portfolio

Bitcoin time preference
Learn Crypto Blog Learn Crypto Blog
Learn Crypto Sep 02 · 5 min read

If you’re thinking seriously about building an investment portfolio then there are some fundamental rules around balancing risk. Though crypto is a brave new world, these rules still apply, so if you haven’t thought about what a balanced crypto portfolio means, now is a good time to start. 

Investing and trading are overlapping ideas that share one basic thing - risk. You are risking your money against an uncertain outcome. The movement of a share price, physical asset (like a house), success of a business or a cryptocurrency trade (short or long term).

Risk means that you might lose the money you invest, which is why you should only ever invest money you can afford to lose, also known as discretionary income.

What a balanced investment portfolio means

If you are willing to risk your money you should have at least some way of measuring how great that risk is. Volatility is the obvious means, how much the value fluctuates. 

Maintaining a ‘balanced investment portfolio’ means structuring the exposure of your investments to an acceptable level of risk. This is normally achieved by splitting your portfolio across two categories with very different risk profiles: capital preservation (low risk/return) and growth (medium or high risk/return).

Capital Preservation vs Growth

Capital preservation should be self-explanatory. The aim is to preserve what capital (money) you have and invest in low risk/low yield assets. In traditional finance this would be fixed income products like bonds, high interest savings accounts or annuities.

In contrast, if growth is your aim you need riskier assets that have the potential to increase significantly in price and grow your capital faster which can range from buying shares in companies (both public & private), buying assets, commodities & cryptocurrency.

So a balanced traditional portfolio might have a mix of bonds & savings products (capital preservation) & growth (shares, assets, crypto etc). 

The balance of those two elements will depend on your circumstances, with your age and discretionary income being significant inputs but a 60/40 split (preservation/capital) is common.

The importance of diversification

Alongside the balance of capital preservation and growth should be a consideration for diversification. In simple terms this means not putting all your eggs in one basket. 

If the growth portion of your portfolio consists solely of shares in companies based in the oil industry and the price of crude collapses, then you're 100% exposed to that risk.

Diversification is a way of mitigating against a complete wipeout of your growth allocation and needs careful consideration because there is no easy way to determine whether any two investments are correlated.

This is especially relevant as we move to discussing how crypto fits into a balanced portfolio, because you’ll find varying opinions on the extent to which the performance of crypto, as a sector, is correlated to mainstream financial indicators such as major stock markets and currencies.

From tradfi to crypto

Moving from traditional finance to crypto you should have an idea that, given its volatile nature, it sits squarely in the ‘growth’ bucket of any portfolio. As mentioned above, your circumstances and risk tolerance would dictate what proportion of the growth segment of your portfolio crypto might account for.

But that isn’t where the discussion ends because a balanced portfolio can be fractal. What that means is that you can subdivide your crypto growth portfolio into a range of assets that sit along a risk spectrum.

So crypto sits within the growth side of your overall portfolio, and within that you invest proportionally in capital preservation and growth of your allocation.

Capital preservation might mean putting a proportion of capital in Stablecoins and choosing established Cefi or Defi providers to generate a fixed return. There would still be counterparty risk from the Stablecoin itself and the chosen yield platform - which is why this within the overall growth proportion of your  portfolio - but low volatility.

Your sub-allocation towards growth within cryptocurrency could itself include coins with varying degrees of risk. This spectrum might run from Bitcoin and Ethereum through established challengers to both, all the way to the newest speculative Defi project on the Binance Smart Chain with allocation in proportion to risk.

You would still apply the logic of diversification as much as you can understand how the crypto ecosystem consists of different sectors with independent prospects for growth.

This is harder than it sounds because you cannot always pigeon-hole what a project does, and because to a large extent prices tend to track what is happening to Bitcoin (known as Bitcoin Dominance). Often crypto - as a whole - can react to major macroeconomic shocks, as was seen at the start of the Covid19 Pandemic.

That being said these fliters/categories would be relevant to diversification, though there are many other ways to classify crypto categories from a diversification perspective.

  • POW blockchains
  • POS blockchains
  • NFT platforms or applications
  • DEFI platforms or applications
  • Oracles/Data services
  • Meme Coins
  • Data Storage

I wanna just yolo

The problem with the idea of a balanced portfolio is that just sounds too damn sensible. You don’t have to look very far on Twitter, Tik-tok or Reddit to see that there is a huge appetite for the complete opposite to balance investment portfolios, epitomised by the idea of YOLO investing.

Yolo stands for you only live once, and basically means going all-in on risky investments. The roots of that movement are complex, and probably have a lot to do with a sense of hopelessness from economic opportunity and distrust of mainstream thought.

By introducing the idea of a balanced portfolio we’re not saying Wallstreetbets has it wrong - though it is extremely high risk - just highlighting the different approaches that exist to investing. YOLO is at one extreme of the spectrum and a balanced portfolio a far more conservative approach.

Crypto or nothing?

The idea of a balanced portfolio isn’t rocket science. Most people with any investment exposure are likely already doing it without consciously mapping it out. 

The difficulty with the idea of crypto making up a proportion of growth within a broader balanced portfolio is that it throws up some difficult contradictions. 

A lot of people are investing in crypto as a replacement to traditional finance, not a complement. Depending on who you follow on social media, you may get a sense that the approach to investment of many within the crypto community goes beyond a financial commitment and is in many ways ideological.

If you see crypto in those terms you might feel that a balanced portfolio approach might not be for you, but this doesn’t have to be a binary decision. You can take the logic of capital preservation, growth and diversification, and apply it however you see fit. 

If for example you fundamentally believe that Defi is going to disrupt traditional financial services you might consider investing in a few Defi platforms and applications that employ different approaches to scaling and where possible diversify any perceived risks. In other words, hedging your bets.

You can preserve capital, and get growth exposure by farming stablecoins, where APYs are much higher than fixed income products in traditional finance.

Whatever decisions you take about building a balanced crypto portfolio make sure it is based on your own research, rather than sketchy info found online, emotion or an irrational desire to make a profit. Employ a realistic time preference, don't expect immediate growth and above all, only invest funds you are willing to lose.