Design a cryptocurrency portfolio

Even if you comprehend the ever-changing fundamentals of cryptocurrencies, investing in this space is still extremely risky. Be sure only to invest what you can afford to lose, and stay focused on tokens that have (or will have) utility to their end users.

Risk

Before we start, let’s go through a gentle reminder of the risks you are taking when investing in the crypto economy and how to mitigate them.

Hackers can steal your funds

Problem

In crypto, you are your own bank and hold the responsibility to store your wealth in a safe place.

You have the choice either to share your private keys to third parties (online wallet), to control and store them in an online environment (hot wallet) or an offline device (cold wallet).

Access to your private keys are vulnerable to digital and physical attacks: if a theft occurs, there is no way to get them back Cybersecurity is a field that is constantly evolving, and you might just never achieve full security.

Solution

However, you can disincentivise hackers to attack you with wallet compartmentalisation.

Wallet compartmentalisation means creating transaction management systems that are never correlated to each other regarding online web exposure.

In other words, if you have three compartmentalised wallet systems, a hacker would take time to spread his attack from one system to another.

One wallet system would be comprised of, for instance, one cold, two hot, and two online wallets (for instance, altcoin exchanges).
If you compartmentalise two wallet systems, this would mean that neither of the two wallets systems can be traced back to the other one (hardware, software, password, transactions).

If a hacker compromises one system, it would be difficult for him to break the other.

Protecting your cryptocurrencies and assets starts with the following:

  • Store most of your wealth on cold wallets.
  • Add an extra layer of protection for hot and online wallets with 2-factor authentification (why not try FIDO U2F standard).
  • Generate strong and unique passwords to lock your private keys.
  • Protect your internet behaviour with a VPN.

This might sound Jason Bourne-esque, but better be safe than sorry!

If you want to learn about wallets and storing your crypto securely, kindly refer to the second part of our crypto 101 series.

Exchanges are unsafe

Problem

We still have to rely on third-party agents when entering the altcoin market as there are currently no decentralised exchanges available. Indeed, only a select few exchanges provide an extensive list of tokens, mostly priced in Bitcoin and Ether.

You will have to send Bitcoins to an intermediate and lose ownership of your private keys to purchase specific tokens.

Furthermore, it can get cumbersome to track your portfolio in different exchanges, as there are only three particular types of exchanges:

  • Fiat to crypto: Accepts fiat as a deposit and is often restricted to a selected few cryptocurrencies such as Bitcoin, Ether and Litecoin.
    Extensive Know Your Customer (KYC) and Anti-Money Laundering (AML) compliance
  • Crypto to Crypto: Lists every digital assets and does not accept fiat deposits.
    Poor or no KYC/AML
  • P2P facilitation: Community platform that matches buyers and sellers. Acts like an over the counter. Available in Bitcoin and Ethereum.
    Poor or no KYC/AML

Solution

  • Avoid storing cryptocurrencies and assets on more than two different types of exchanges.
  • Keep most of your tokens on hot and cold wallets and trade with approximately 20% of your portfolio. If something averse happens to the exchange, you’ll still have some crypto available.
  • Protect yourself against attackers and lock your account with 2-factor authentification.
  • Understand that hackers have targeted exchanges and stolen millions of dollars in the past. It can happen again.

Volatility can make me lose everything

Problem

The notion of value in crypto has become very controversial and still subject to many debates. Public opinion is split between those who think crypto is going to change the world and others that think it’s just a scam.

Thing is, mainstream media shares and writes from both points of view:

Negative

  • JP Morgan’s CEO Jamie Dimon thinks Bitcoin is “a fraud” and “eventually it will be closed”.
  • Many media outlets such as NY Times, Forbes and Fortune have stated that the cryptocurrencies are in a bubble.

Positive

  • Microsoft founder Bill Gates thinks that “Bitcoin is a technological tour de force”.
  • Former US Vice President Al Gore states that “an algorithm replaces the function of the government …[that] is actually pretty cool.”
  • IMF President Christine Lagarde stated that “digital currencies are here to stay.”

Truth is, you can lose your money very quickly in crypto, especially when trading on crypto to crypto pairs. It is not uncommon to witness colossal price volatility, up to 60-70% loss in a matter of weeks.

Investing in the wrong assets can dilute your position and tear your portfolio apart.

Solution

  • Understand that Bitcoin is a threat to central and private banks as it disintermediates the process of payment and offers transparent emission rates.
  • Most of “old school” bankers and regulators will spread FUD (Fear, Uncertainty, Doubt) about the future of crypto.
  • Keep some established cryptocurrencies (Bitcoin, Litecoin, Ethereum) stored in cold wallets with a long-term return on investment timeline in mind.
  • No need to become a professional trader in a day, buy your tokens, store them in a safe place, sit back and relax.

There are so many tokens out there, most are going to die

Problem

CoinMarketCap has listed more than a thousand tokens in their database.
Coupled with the increasing amount of platforms that facilitate the creation of tokens and initial coin offerings for less tech-savvy individuals, we can only assume there will be significant growth in issuance of tokens in the future.

Today, depending on the jurisdiction, ICOs and tokens are either unregulated or banned. Most of them might not exist in the next few years, so it’s important to take into account the following factors before investing:

  • Anyone can issue a token with minimal programming skills.
  • Blockchain tech moves at such a pace that any token can become obsolete.
  • Tokens without active developers cannot compete in the market.
  • Certain markets already have a high concentration, i.e. privacy-focused tokens or smart contract development platforms.

Solution

  • Understand the utility of a token before investing. Never invest in technology you do not understand.
    Even if the technology appears to be advanced, the token’s founding team should be able to explain it in simple words.
  • Diversify your crypto portfolio based on industry, market capitalisation, geography, token generation, platform, consensus type and more. Kindly refer to the third part of this chapter “Diversification”.

All of the above makes it high intensity and quite stressful

Problem

We are still at an early stage in cryptocurrency, since the market is in testing mode, most assets might become obsolete.

With all the price volatility, hacking risks and fraudulent investment opportunities, cryptocurrency investors are vulnerable to lose their capital in a short amount of time.
Inversely, prices might go through the roof and return considerable profits.

On the one hand, cryptocurrencies have introduced new financial instruments to investors, but on the other hand, they also come with substantial risks.

Having the opportunity to transact in the flourishing decentralised economy and keeping control over your capital comes with a new set of externalities that might just make your day a little bit more stressful and a bit more exciting.

Solution

It’s not because you have entered the crypto market that you have to change your investment behaviour and decision making.

If you set up your wallets as explained in chapter two, this will reduce the probability of a digital attack.

Set-up

“I always tell them (my family) that the second most stupid thing they could do right now is to own an amount of bitcoins they cannot afford to lose and the most stupid thing they could do would be not to own any.”

Wences Casares, Xapo CEO

Before you start, get the technical literacy to know how to secure your tokens, send them across wallets and build your transaction systems.
Just like in the real world, you’ll have to set up savings and current account in cryptocurrency.

Then document yourself on what’s happening in the space before you start diversifying.
Modern portfolio strategy is an investment strategy based on asset diversification: you don’t have to put all your eggs in one basket. Your portfolio’s level of diversification should illustrate your risk appetite.

Here are some variables to take into account when building a customised and diversified portfolio.

Unit of account

There are currently two units of account in the cryptocurrency economy:

Fiat to crypto

Only established and high market capitalisation tokens are listed with fiat currencies, less than fifty. A majority of the remaining thousand tokens are priced in Bitcoin and Ether.

Most of the fiat to crypto exchanges only sell Bitcoin, Litecoin and Ethereum.

Investing in crypto with fiat means betting the price of a unit of crypto will increase

BTC / ETH to crypto

Every single token is priced in Bitcoin, and a majority are also priced in Ether.

A jump in fiat price of Bitcoin or Ether will suddenly increase the market capitalisation of every token.

For instance, if Ether goes from $250 to $500 per unit, tokens listed in Ether will see their market capitalisation double in the same amount of time. In this scenario, this would create a downward pressure (sell) on altcoins.

Investing in an altcoin with Bitcoin or Ether implies that the price of the altcoin will increase faster than the price of Bitcoin or Ether in fiat.

Industry

An easy way to build your portfolio is to diversify it according to market and product. For instance, here's a few digital asset industries you can screen:

  • Smart contract: Ethereum, NEO
  • Asset management: Iconomi, Numerai
  • Gaming: GamingCredits, FirstBlood
  • Attention economy: Basic Attention Token, Steemit
  • Prediction market: Augur, Gnosis
  • Privacy-focused: Monero, ZCash

Capitalisation level

The crypto market offers large market cap tokens as well as “penny” tokens with a minuscule total token supply valuation. Naturally, the larger the market capitalisation, the more established it is considered by the market.

It is important to evaluate tokens based both on total supply and circulating supply.

Additionally, a large market capitalisation does not necessarily mean an investment is less risky: the price can drop and dilute your position.

  • HIGH: Top 20-30 tokens
  • MID: Tokens with a valuation of more than $50-$100 million
  • LOW: newly introduced tokens with low valuations
  • ICO: Tokens about to be launched by their founders

Token generation

Cryptocurrencies have evolved extensively in the past decade.
While Bitcoin, the first blockchain use case, disrupts the payment industry, other tokens have emerged and improved the scope of the technology.

1st gen: Payment protocol

Bitcoin and Litecoin amongst other first-generation tokens provide the same utility to their respective users: the ability to transfer value rapidly from one peer to another.

2nd gen: Smart contract development

The second generation, pioneered by Ethereum, enables the development of smart contracts on top of a blockchain.
More than settling financial transactions, the second generation facilitates the access to blockchain technology, supplies a cryptographic and mining environment, and allows software to mature.

3rd gen: Decentralised applications and tokenised assets

The third generation relates to tokens that are built on top of an existing blockchain.
Rather than building a new blockchain from scratch, these tokens leverage already existing platforms to build an application on top of them.

Consensus

Cryptocurrencies started off with Proof-of-Work consensus where miners invested in hardware, energy and time to secure the network and reach distributed consensus.

Alternatively, Proof-of-Stake consensus enables token holders to stake their capital to verify transactions and earn rewards from. Other consensus protocols include Federated Byzantine Agreement, Proof-of-Service or Proof-of-Burn.