Hey everyone, it’s Whatever Wednesdays again. Today I’m going to talk about “Crypto Diversification“.

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Crypto Diversification?

Yea.

I think everyone seems to agree that:

“The most basic – and effective – strategy for minimizing risk is diversification.” from Investopedia

We see it everywhere. It’s one of the most basic reasons to use an index fund rather than picking individual stocks. A larger exposure means less risk.

Simple right?

Well kind of.

The problem with this “basic strategy” is that I think people extrapolate it to be more broad than it was intended to be used for. In my opinion, it’s best used when referring to index funds. You want broad market exposure because you believe that overall, over a long arc of time, the stock market (as a whole) will be higher than when you originally invested.

However, people also extrapolate this to mean that they should be in other markets that are potentially more risky, and usually they don’t understand very well. For example, let’s say you own $100 in Apple stock and $100 of Google or something. Then you read about FAANG (Facebook, Apple, Amazon, Netflix and Alphabet’s Google), so you “diversify” by buying $100 of Facebook, Netflix, and Amazon. However, this really isn’t diversifying. This is just spreading yourself across multiple tech stocks. This doesn’t necessarily decrease your risk.

What matters is the broader picture for how you’ve invested. For example, if you have $10,000 in a three fund portfolio, and you have $500 in the FAANG stocks, then honestly it doesn’t really make a difference. The majority of your money are in index funds, so your $500 in FAANG stocks doesn’t really do anything. However, if you have $2000 in each FAANG stock, and $0 in index funds, then your portfolio is not diverse at all. You are essentially betting only on these tech stocks with all your money — which is very risky.

So, the big picture is what matters then?

Yes.

This is the reason that I think the idea of a “diverse” crypto portfolio doesn’t make sense (for most people). Like I said before, I have only a very tiny amount of money in crypto. The majority of my money is in my 401k and other retirement plans with approximations of a 3 fund portfolio. For the other smaller accounts I just stick to my three fund portfolio.

For this reason, I place my crypto into a completely separate asset class… I call it GAMBLING.

The reason for this is because unlike my sentiment for the overall stock market, which is that I believe it will go up overall, over a long arc of time… for the crypto market it’s much different. There are 1600+ cryptos that exist today, but I think 90% of them are garbage. Another 5% of them just won’t make it over the next 5 years. Only the remaining 5% will offer something to the world. So 5% of 1600 = 80. So approximately 80 coins or so are actually important and worthwhile… the question is which ones? Additionally, there may be coins that come up in the next 5 years that aren’t even on the radar yet that will continue to live on as well. Who knows?

So then I ask you, if you don’t believe in the crypto market as a whole — why diversify? 

In my opinion, just pick a few coins you believe in and just see where they go. Only invest (gamble) what you can afford to lose.

The only reason I see to diversify is if your entire life savings is in crypto… and that is just crazy to me. Let’s say you create a crypto portfolio of 50 coins you believe in. According to my 5% theory, maybe 2 or 3 of those 50 will continue to exist. Let’s even say you did well in choosing and you were able to guess the 5 coins that made it through. The other 45 coins you put money into are essentially worthless. They may still have “theoretical” value but they are essentially dead coins with no liquidity and no one to buy them.

Basically, you’re betting the 5 that make it through are able to offset the 45 you will lose everything on.

We’re still in the wild, wild west.

People seem to think that crypto is where dotcom was in 2005, but in my opinion (and Charles Hoskinson’s), we’re actually closer to 1992. Who knows how long it will take for mass adoption of crypto. Perhaps we will see it happen faster than the internet, but it also could potentially take longer.

Until the market matures enough to have a reasonable amount of value producing coins, I don’t see a reason to diversify. The crypto market will need to be strong enough and stable enough for me to believe in the market as a whole before I think it makes sense to diversify. By this point, I would imagine that there would be many, many different “crypto mutual funds” to chose from. In that sense, you would just put a smaller % into your portfolio, like 5% or so, and just consider it a “high risk, high reward” asset class.

I’m sure people will disagree with me and perhaps call me an idiot. However, diversifying in an asset class which I consider to be “gambling” is like going to Las Vegas and throwing money on 5 different roulette tables with different odds at the same time instead of just gambling at one. It doesn’t make any sense.

TL;DR

Crypto diversification doesn’t make sense to me.

I understand for some who have their life savings in crypto, it may make more sense.

However, given my overall sentiment of the crypto market, the idea of that is way too risky.

I think we’re closer to 1992 than we are to 2005.

-Sensei

Agree? Disagree? Questions, Comments and Suggestions are welcome.

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