Mastering Risk: 7 Techniques for Cryptocurrency Portfolio Management

A growing number of people are using cryptocurrency investing to diversify their portfolios and possibly make large financial profits. On the other hand, investors in cryptocurrencies may be exposed to significant financial risk due to the market’s extreme volatility. To protect their money and negotiate this treacherous landscape, cryptocurrency investors must implement efficient risk management techniques.

In this comprehensive article, we’ll walk you through the top 7 tactics (and bonus tips) for managing risk in a cryptocurrency portfolio.

Risk Management Techniques for Cryptocurrency Portfolios

Given the extreme volatility of cryptocurrency assets, portfolio managers must effectively manage risk. Cryptocurrencies, in contrast to conventional currencies, are not subject to government regulation, are susceptible to hacking, and are subject to sudden price swings caused by speculation and market mood.

Effective crypto risk management techniques could help you reduce losses, maximize profits, and keep your portfolio well-balanced and in line with your risk tolerance and financial objectives.

Now that we are aware of the need for risk management in bitcoin trading, let’s get into the real tactics!

1. The act of diversification
   As a risk management tactic, diversification entails distributing your assets among several blockchain technologies, industries, and cryptocurrencies. By spreading your investments over a variety of cryptocurrency assets, you may reduce the risks associated with owning a single asset that can suddenly lose value owing to unanticipated events.

Additionally, portfolio diversification can assist in capturing possible profits from various markets and underlying asset classes. Cryptocurrency investors may profit from the growing potential of diverse areas of the industry by distributing their assets among many currencies with varying use cases, market segments, and technological breakthroughs.

Risk-based diversification (RBD), sector-focused diversification (SFD), thematic diversification (TD), market cap-based diversification (MCBD), time-horizon-based diversification (THBD), etc. are a few strategies for diversifying your investment portfolio.

A portfolio of RBD coins may include the following:

• Bitcoin (high liquidity, low volatility, low risk)
• Ethereum (more liquidity, higher risk, and increased volatility)
• Binance Coin: moderate volatility, mid-risk, and high liquidity
• Chainlink (more volatility, more risk, and less liquidity)
• Uniswap (moderate liquidity, higher risk, and increased volatility)
• USD Coin (stable, high liquidity, low risk)
• Solana: moderate liquidity, high volatility, and increased risk.

➔ This is an example of an SFD portfolio:

• Maker (MKR), Compound (COMP), and Aave (AAVE) comprise the DeFi (Decentralized Finance) Sector.
• Chiliz (CHZ), Flow (FLOW), and Enjin Coin (ENJ) are in the NFT (Non-Fungible Token) sector.
• Sector of Gaming: Decentraland (MANA), Axie Infinity (AXS), and Theta Token (THETA)
• Chainlink (LINK), Cardano (ADA), and Polkadot (DOT) comprise the infrastructure sector.

➔ Here are a few TD portfolio examples:

• Themes for Decentralized Finance (DeFi): Compound (COMP), Uniswap (UNI), Aave (AAVE), and Ethereum (ETH)
• Themes related to privacy and anonymity: Dash (DASH), Zcash (ZEC), Monero (XMR), and Pirate Chain (ARRR)
• Themes related to energy efficiency: Solana (SOL), Cardano (ADA), Ethereum (ETH), and Chia (XCH).
• These are the games and NFT themes: The Sandbox (SAND), Decentraland (MANA), Enjin Coin (ENJ), and Axie Infinity (AXS).
• Theme for the Internet of Things (IoT): VeChain (VET), Waltonchain (WTC), Helium (HNT), and IOTA (MIOTA)
• Polkadot (DOT), Chainlink (LINK), Filecoin (FIL), Arweave (AR), and The Graph (GRT) are the Web 3.0 theme.

➔ Examples of market-cap-based cryptocurrency portfolios are shown below:

Large-cap cryptocurrencies: These include Bitcoin (BTC), Ethereum (ETH), and Binance Coin (BNB), and they are the least volatile and most well-known cryptocurrencies having a market capitalization of over $10 billion.
Mid-cap cryptocurrencies: Usually relatively new, these have a market capitalization of $1 to $10 billion and are becoming increasingly well-liked and used. Polkadot (DOT), Chainlink (LINK), Solana (SOL), and more examples are a few.
Small-cap cryptocurrencies: Usually consisting of unproven, recent projects with a market capitalization of under $1 billion, these are the most volatile type of cryptocurrencies.

➔ Let us examine several instances of diverse portfolios based on temporal horizons:

Bitcoin (BTC), Ethereum (ETH), Binance Coin (BNB), Polkadot (DOT), and Solana (SOL) are short-term (one to six months) investments. Investing in these assets carries a higher risk but also yields large profits quickly.

Bitcoin (BTC), Ethereum (ETH), Cardano (ADA), Chainlink (LINK), and Uniswap (UNI) are among the medium-term (6–12 months) investments. This portfolio has prospects for development and is less erratic.

Bitcoin (BTC), Ethereum (ETH), Polkadot (DOT), Chainlink (LINK), and Cardano (ADA) are long-term investments (12+ months). These currencies are anticipated to increase in value over time due to their robust use cases and strong development teams.

➔ The following highlights some cryptocurrency types to think about for diversification:

The first and biggest decentralized digital money in the world is called Bitcoin. Without question, one of the most well-liked options for diversifying a cryptocurrency portfolio is Bitcoin. Cryptocurrencies that are not Bitcoin are called altcoins, “alternative cryptocurrencies.” This asset class was developed to diversify the cryptocurrency market as an alternative to Bitcoin.

Since altcoins are more volatile and frequently have smaller user populations than Bitcoin, they are considered riskier than Bitcoin. They do, however, also provide a bigger return possibility to investors with a high-risk profile. Additionally, altcoins are classified as Layer 1 and Layer 2 coins according to the blockchain technology they use.

Utility tokens and DeFi projects: Blockchain-based businesses generally issue utility tokens to encourage users to engage with the network. Purchasing utility tokens has the potential to yield significant profits provided the underlying good or service becomes well-known and widely used. Exposure to a range of financial services not accessible for typical investments through traditional financial institutions can be obtained by investing in DeFi ventures. But keep in mind that DeFi initiatives may be quite dangerous and difficult.

NFTs are distinct digital assets that are kept on the blockchain and cannot be copied or traded for other assets. They frequently stand in for souvenirs, artwork, and in-game goods. NFTs provide a fresh approach to cryptocurrency investing with enormous growth potential. However, NFT investments tend to be extremely risky and speculative. The popularity of the underlying digital asset, the NFT’s rarity, and the general mood of the market may all affect how much an NFT is worth.

Stablecoins are virtual currencies that are linked to a reliable fiat currency, such as gold or the US dollar. Because they may be traded for one or more fiat currencies, they offer protection against the volatility of the cryptocurrency market and can be used as a store of value or as a method of payment. Purchasing stablecoins lowers the volatility of a cryptocurrency portfolio and offers investors a reliable passive income stream. Because of their consistent value, stablecoin investments don’t have the same potential for large returns as those made in other cryptocurrencies.

By additionally making investments in conventional financial markets and other non-crypto assets like bonds, real estate, and equities, you may further diversify your investment portfolio.

2. Averaging Dollar-Cost (DCA)

Regardless of market circumstances, dollar-cost averaging is a straightforward technique that entails investing a certain amount of money on a monthly basis. This approach aims to lessen the portfolio’s exposure to market volatility and assist investors in avoiding rash financial decisions based on transient market swings.

Suppose you wish to use the DCA technique to invest $500 in BNB over five months. You resolve to put $100 down each month, no matter how much the BNB costs. Let’s see how this transpires:

First Month:

$200 for BNB
$100 was invested.
BNB acquired: 0.5

Second Month:

$250 for BNB
$100 was invested.
Purchased BNB: 0.4

Third Month:

Price of BNB: $300
$100 was invested.
Purchased BNB: 0.3333

Fourth Month:

$350 is the BNB pricing.
$100 was invested.
Purchased BNB: 0.2857

Fifth Month:

Price of BNB: $400
$100 was invested.
BNB acquired: 0.25
$500 total invested

Purchased BNB in total: 1.769

Over five months, you have amassed 1.769 BNB using the DCA approach. During this time, the average price of BNB was ($200 + $250 + $300 + $350 + $400) / 5 = $300. The BNB you purchased on average costs $500 / 1.769 = $282.55. In this instance, the DCA approach produced a purchase price average that was lower than the investing period’s average price overall.

By reducing your average purchase price relative to the average market price, the DCA method lets you profit from the increasing trend in the price of BNB as it climbed over time. When investing in the market without attempting to time it, DCA might be a helpful tactic. Investors may take advantage of compound interest and meet their long-term financial objectives by making consistent investments over time.

3. Size of Position

Position sizing is a risk management strategy that establishes the right size of a position or investment depending on the level of risk an investor is ready to accept. Using this method, an investor determines the highest possible loss they are willing to accept and modifies the size of their investment appropriately. Position size is relevant to different investment and asset management types, even though it’s frequently associated with cryptocurrency trading strategies.

To reduce possible losses, an investor should change the size of their position if, for instance, they are ready to assume a 5% risk on a single transaction or position. This helps investors stay away from taking on too much risk and maybe losing more than they can afford.

Position size can help investors manage their risks more successfully and increase their chances of success in the markets when used in conjunction with other risk management techniques.

4. Rebalancing a Portfolio

Rebalancing a portfolio is modifying its holdings to return them to their initial allocations of assets. It guarantees that the risk-reward ratio of the portfolio stays in line with the investor’s objectives and risk tolerance.

Rebalancing can assist investors in maintaining their preferred degree of risk exposure while perhaps boosting their profits, given the considerable fluctuations in bitcoin values. For instance, an investor may choose to sell some Bitcoin and purchase more Ethereum to get their portfolio back to the target allocation if, as a result of market fluctuations, their portfolio now comprises 60% Bitcoin and 40% Ethereum instead of the 50% that they had originally intended.

Utilizing a reliable crypto tracker to monitor portfolio allocations and performance can streamline the process of rebalancing, providing real-time insights into asset distributions and facilitating informed decisions during portfolio adjustments.

Periodically, as on a monthly or quarterly basis, rebalancing can also be carried out in response to specific events, like a notable shift in the value of a single cryptocurrency or a modification in the investor’s risk tolerance or financial objectives.

5. Orders to Stop Losing
   An effective technique that enables investors to automatically sell all or a portion of their assets if the price of a certain asset drops below a predefined threshold is a stop-loss order. Investors can safeguard their assets from large decreases and minimize their losses during abrupt market downturns by putting in a stop-loss order.

In a bear market, for example, if an investor purchases Ethereum for $2,000 and places a stop-loss order at $1,800, their Ethereum holdings would be immediately liquidated if the price falls to or below $1,800.

Furthermore, investors may monitor their cryptocurrency assets with the use of price alerts like CoinStats alerts. These notifications let investors know when a certain cryptocurrency investment hits a certain price or moves significantly, or when a major news outlet publishes breaking news that might affect the market.

6. Protecting

Hedging is a strategy used to protect an investor’s assets from unfavorable changes in the market. This is achieved by taking a position that offsets the initial investment’s risk exposure.

As an example, one can short a Bitcoin futures contract to protect their Bitcoin holdings. If the price dropped, the earnings from the short position would have outweighed the losses on the investment. Another type of hedging is locking in earnings amid market volatility by adopting stablecoins, which have a constant value in comparison to other cryptocurrencies.

Bonus Tips on Managing Risk Effectively
Given that we’ve established the most widely used crypto portfolio risk management techniques, let’s look at some tips to assist investors get the most out of market swings.

Exercise Caution
Before investing in any cryptocurrency, investors need to do extensive research. To make informed decisions, ensure conducting your own research and evaluate the team, technology, use cases, and market potential.

For example, it’s critical to investigate the team members’ backgrounds, analyze tokenomics, appraise the security and scalability of the technology, gauge the platform’s potential to upend both the DeFi ecosystem and the current financial ecosystem, and determine the size of the overall market before investing in a new DeFi project.

Utilizing a reliable crypto tracker can provide real-time insights into your portfolio’s performance and aid in making informed investment decisions amidst the dynamic cryptocurrency market.

Determine Your Tolerance for Risk
One of the most important aspects of portfolio management is determining your level of risk “appetite” before making any investing decisions. Take into account important elements like your own investing horizon, financial objectives, and situation in life.

Prioritizing more reliable digital assets like Bitcoin and Ethereum and embracing a more passive investment approach are best practices for a cautious investor with a low tolerance for risk. On the other hand, risk-takers who are ambitious and have a high tolerance for risk can go for riskier investments that could result in bigger profits, such as small-cap altcoins or recently established crypto ventures.

Keep Up With It
It will take considerable effort to stay current on the most recent news, events, and market trends in the cryptocurrency area if you intend to actively manage your portfolio.

Ensure monitoring of the cryptocurrency market and your overall investment by subscribing to reputable and unbiased news sources, social media platforms, and community forums. You may think about joining relevant Telegram and Discord groups, subscribing to newsletters from reliable sources like CoinStats, CoinDesk, and Cointelegraph, and following experts and influencers on Twitter and LinkedIn.

Only Make Investments You Can Afford to Lose
Investing in cryptocurrency markets always entails the risk of losing part or all of your money since they may be extremely volatile. Ensure investing no more than you can afford to lose without endangering your capacity to make ends meet.

If you’re new to investing in cryptocurrencies, start small with a modest amount you are comfortable risking and grow your stakes gradually as you acquire confidence and expertise.

Making an exit strategy ahead of time can assist reduce losses if things don’t turn out as planned. This can serve as an effective way to manage your portfolio. This indicates that you have identified the right time to enter the market, take a profit, and close the position if the transaction doesn’t work out.

Be Mindful When Using Leverage
By enabling you to borrow more money for investments, leveraged trading can increase your returns but also increase your losses. Utilizing leverage requires caution and a thorough understanding of the associated hazards.

As you gain confidence and skill in the procedure, start with a lower amount of leverage and raise it gradually. Start with a 2x or 3x leverage, for instance, if you’re trading on a margin platform instead of going to a greater level, which might result in substantial losses if the market goes against you. Always keep in mind that there are dangers associated with larger leverage, so utilize leverage carefully and only with risk capital you can afford to lose.

Summary

Cryptocurrency investing may be rewarding but also involves a lot of study, preparation, and risk management techniques. You can increase your profits, reduce your losses, and create a stable portfolio that can withstand the volatility of the cryptocurrency market by putting these strategies and suggestions into practice.

Remember to diversify your assets, evaluate your risk tolerance, carry out your research, keep up to date, invest only money you can afford to lose, and exercise caution when it comes to leverage risk. These tactics can assist you in navigating the complexity of the cryptocurrency market and achieving your financial goals when paired with discipline and patience.

Thus, invest time in educating yourself, maintain your focus on your long-term goals, and keep a close eye on the dynamic cryptocurrency scene. If you approach and think about your crypto investments correctly, you can make them profitable and successful.