Disclosure: This article is for information purposes only and should not be considered as investment or tax advice. The author does not endorse any of the products discussed.
Cryptocurrency headlines are becoming increasingly popular. In financial media they have carved out quite the niche over the past decade. Cryptocurrencies are attractive to DIY investors because of the astronomical gains they post, but it is also important to note their losses. With an understanding of basic investing principles and the cryptocurrency environment, one could feel confident in allocating a portion of their investment portfolio to cryptocurrencies.
When you begin to look at investing in cryptocurrencies, it is important to have a strategy. There are many options for an investor to explore, so classifying them by risk is a good start. Most readers will know of the most popular offerings, such as Bitcoin, Ethereum and Litecoin, but there is also a constant flow of newly available coins formed through Initial Coin Offerings. Because of this, cryptocurrencies should be divided into three simple categories in an investor’s mind: Established and Accepted Coins(EACs); Established Coins(ECs); and New Coins(NCs).
Any cryptocurrency investment involves a significant amount of risk. The variance in volatility between these three categories can be likened to traditional investment vehicles, namely bonds, mutual funds, and individual stocks. Bonds are inherently less volatile than mutual funds, which are in turn less volatile than stocks. In much the same fashion, EAC volatility is less than EC volatility, which is less than NC volatility. However, all of the aforementioned investment options run the risk of their worth suddenly becoming $0.
Established and Accepted Coins
Coins that should be considered Established and Accepted Coins are those that share the following characteristics with Bitcoin and Ethereum. They are in the top ten cryptocurrencies by market cap, they have existed for a minimum of two years, and they are accepted forms of payment. For any cryptocurrency portfolio EACs should form the core, around 50% of the value. They are the most liquid and the least likely of the cryptocurrencies to rapidly and permanently lose their value. The days of doubling overnight are probably over, but the long-term growth prospects coupled with relative stability makes them a must hold for the crypto investor.
The second category, Established Coins, should have the two following characteristics. An EC should be ranked highly by market cap, although not necessarily in the top ten. It should also have at least one year of trading history. These coins may or may not be accepted as payment, even on the web, but daily trading volume still allows for some measure of liquidity. A bonus for ECs, as with all coins, is if they are somehow differentiated from other cryptocurrencies. After all, if they are to carve out their own market share among the EACs they must bring something new to the market. Established Coins should form anywhere from 25 to 35% of your portfolio. An example of an EC would be IOTA.
The final and most speculative category of cryptocurrencies is the New Coin. Just because a coin is not an EC or EAC, does not make it a New Coin. New Coins must have a differentiating characteristic to earn the NC brand. They could be backed by a new technology, or they could be quasi shares in a real-world enterprise. These desired characteristics will change from investor to investor, based on what they believe to be valuable.
New Coins often have low trading volume and as such are not very liquid. When investing in an NC, the hope is that in the future it will become an EC and then an EAC. If this is unlikely, it is probably best to leave that coin unpurchased. Due to the high volatility and lack of liquidity, NCs should not form more than a quarter of your portfolio, perhaps even less. 15 to 25% would be an appropriate weighting. ASTRO token is an example of an NC.
As with any investment, cryptocurrencies could result in you losing all of your investment. However, as they become more regulated and more widely accepted their volatility should reduce and ICOs should continue their morph into IPOs. The lines between EACs and ECs, as well as ECs and NCs are blurred, just as the definition of a blue-chip stock will differ from investor to investor. The final decision to purchase any cryptocurrency lies with you.