Cryptocurrencies currently outnumber fiat currencies by nearly tenfold. But even with the flood of crypto assets, there are practical ways investors can separate the wheat from the chaff.
In early 2014, the hype around Bitcoin–which months earlier had crossed the $1,000 threshold for the first time–was inescapable. According to some, the new currency had touched the sky and there would be no turning back–Bitcoin was headed to the moon.
This first round of crypto euphoria, coupled with an increased understanding and general excitement over Bitcoin’s groundbreaking ingenuity, sparked the emergence of about a dozen new cryptocurrencies. Most of them, including Litecoin, Ripple, and Monero, are still around today. One of them–Coinye West–is not.
Not surprisingly, the coin’s namesake didn’t find the word play amusing. Within days of its launch, Kanye’s lawyers effectively ended Coinye’s short life.
The Coinye experiment is a good reminder that low barriers to entry in the crypto space have allowed nearly anyone with the time, talent and inclination to launch their own cryptocurrency.
According to CoinMarketCap there are more than 1,500 cryptocurrencies representing nearly $400 billion in market capitalization. If growth trends continue, there will soon be more cryptocurrencies traded than stocks on the NYSE.
But how do you know which of these crypto assets are worthy of investment? While coin names like DopeCoin, LetItRide and HoboNickel don’t scream “safe investment,” there is certainly opportunity to diversify your investments in this emerging technology beyond just Bitcoin.
There are really two ways to think about crypto asset diversification.
- First, how do investments in crypto assets collectively impact your overall asset allocation (e.g., how does a pool of crypto assets correlate to your stock, bond and other investments)?
- Second, how can buying individual cryptocurrencies help reduce the risks posed by investing too narrowly in the space?
While there are many different angles to approaching the latter concept above, here are a few of the most important things to think about when evaluating individual cryptocurrencies.
- Coin or Token? The term cryptocurrency is used broadly, when in fact the word really captures two types of crypto assets–coins and tokens. At the most basic level, coins such as Bitcoin’s BTC, Litecoin’s LTC, and Stellar’s XLM transfer a unit of value from one person to another. Tokens, on the other hand, are typically run off Ethereum’s platform and can transfer just about anything from one party to another that would previously have required a trusted intermediary. Investing in crypto can be very different depending on the purpose of the coins and token. For example, tokens have been used for initial coin offerings (ICOs), an area that has been scarred with highly speculative and sometimes fraudulent behavior. ICO investing is far different than buying BTC or other coins, which share few of the same characteristics of ICO tokens.
- Size Matters. It’s important to remember that while there are many coins and tokens, a very small group makes up most of the market. In fact, the largest 20 cryptocurrencies account for nearly 90% of the sector’s market capitalization. Investing in cryptocurrencies that are more frequently traded and liquid (in relative terms), might not provide the quick profits some investors are hoping for with crypto, but as with stocks and other traded assets, less liquidity typically means more risk. Still, there are plenty of smaller crypto assets with merit, and depending on your risk tolerance some of these coins and tokens may be worth consideration.
- Who’s in Charge? Bitcoin was created to be a completely decentralized peer-to-peer network, but as the broader crypto landscape has evolved cryptocurrencies have taken varying approaches to governance. While most still target a decentralized approach, some have policies that centralize some decision making, raising questions over governance. For example, Ripple doesn’t rely on distributed mining for its coin XRP and many have argued Ethereum’s founder has outsized influence over coding changes. While it can be difficult to precisely decipher governance models, investors should prioritize having some understanding of a cryptocurrency’s protocol, and maybe more importantly, how changes to its rules can be made.
These guideposts are in no way exhaustive. There are, of course, many other factors investors should consider before jumping into buying and selling crypto assets. The experience of the team, the track record of the cryptocurrency, and the transparency of its operation are all as important in crypto as in other areas of investing. In other words, if you buy a coin or token created in a dorm room last week, don’t be surprised when it goes belly up.
The flashing lights of crypto can no doubt be distracting, especially in light of recent price surges with so many of these assets. In the current environment, taking a measured, well-informed approach to crypto investing is easier said than done.
In one of his infamous tweet storms, Kanye recently posted “decentralize,” a word that may best define the philosophy behind cryptocurrencies. Maybe KanyeCoin is next?