Investing In Multiple Cryptocurrencies: How Many Is Too Many?

Cryptocurrency is a highly volatile investment option that has given some people huge returns while causing others to lose millions. While it is possible to get rich by investing in cryptocurrency, it is also very possible to lose all your money.

Cryptocurrency is a decentralised and secure digital currency, based on blockchain technology. It is not issued by any central authority, which makes it susceptible to huge swings in price.

If you are considering investing in cryptocurrency, it is recommended that you do so as part of a diversified portfolio. Allocating a small percentage of your portfolio to cryptocurrency can give you exposure to this asset class without damaging your finances.

It is important to do your research and only invest money you can afford to lose. The cryptocurrency market is highly speculative, and the price of a cryptocurrency can fluctuate wildly based on news and market sentiment.

Some popular cryptocurrencies to consider investing in are Bitcoin, Ethereum, Litecoin, and Ripple. These cryptocurrencies have performed well over the years and are widely recognised.

Remember, investing in cryptocurrency is risky, and there is no guarantee of returns. Always do your due diligence before investing and be prepared to lose all your money.

Diversification and correlation

Diversification is a practice of not putting all your eggs in one basket, so you don't lose everything when problems arise. However, diversification has its costs, such as limiting your upside potential and incurring extra fees for management and upkeep.

An important exception to diversification is that it only works if the assets you choose are uncorrelated with each other. Most of the time, most coins move in tandem, making it challenging to achieve true diversification within a crypto-only portfolio.

To achieve effective diversification, consider including other asset classes in your portfolio, such as stocks, bonds, or real estate. By allocating your investments across multiple uncorrelated assets, you can reduce the overall risk and improve your risk-adjusted returns.

Additionally, when investing in cryptocurrencies, it is essential to have a long-term perspective. Short-term price fluctuations can be volatile, and trying to time the market is challenging. Focus on the underlying technology, use cases, and adoption rates of the cryptocurrencies you invest in rather than getting caught up in short-term price movements.

Remember, investing in cryptocurrencies is risky, and you should only invest what you can afford to lose. Always do your research and consult with a financial advisor before making any investment decisions.

Volatility

Factors Affecting Crypto Volatility

Crypto is a relatively new asset class, and as such, it is still in the process of finding its feet. The market is still relatively small, with a total market cap of $2.1 trillion compared to the U.S. stock market's $44.85 trillion. This lack of liquidity can make it difficult for large traders to enter or exit the market without affecting prices.

The distribution between supply and demand also plays a role in crypto volatility. The limited supply of certain assets can create conditions where sudden increased demand can put upward pressure on prices. Bitcoin, for example, has a supply cap of 21 million coins. Large holders, often called whales, can also influence prices by buying or selling significant quantities of a particular asset.

The immaturity of the crypto market means that it is heavily influenced by investor sentiment. Positive or negative news can spread like a contagion, and the psychology of the typical crypto investor—an individual/retail investor who is less informed and more impressionable than traditional investors—can lead to exaggerated reactions to events that would have a more muted impact on traditional markets.

Reducing Risk

Retail investors are generally advised to diversify their investments to reduce risk. This can mean investing in a basket of stocks or an index fund rather than just a few individual stocks. It can also mean pairing investments in more volatile asset classes with less volatile ones, such as bonds.

When it comes to crypto, investors can also consider stablecoins, which are cryptocurrencies specifically designed to have low volatility. These coins are pegged to a reserve asset like the U.S. dollar, which helps to stabilise their price.

Long-term vs short-term investment

The number of cryptocurrencies one should invest in depends on a variety of factors, including financial goals, risk tolerance, and investment strategy. Diversifying your portfolio by investing in multiple cryptocurrencies can help spread risk, but it's important to remember that investing in cryptocurrencies carries substantial risk and should be done cautiously.

Now, let's delve into the differences between long-term and short-term investment strategies in the context of cryptocurrencies:

Long-term Investment:

Long-term investment in cryptocurrencies involves holding digital assets for an extended period, often for years. This strategy focuses on the potential long-term growth of the cryptocurrency market and aims to capitalize on its upward trajectory over time. Here are some key characteristics and considerations for long-term crypto investment:

• Long-term investors are less concerned with daily price fluctuations and short-term volatility. They adopt a buy-and-hold strategy, believing in the fundamental strength and real-world utility of the assets they invest in.
• This approach requires patience and a long-term perspective. It is less risky compared to short-term trading but demands perseverance through market ups and downs.
• Long-term investors typically conduct thorough research on the technology, fundamentals, and growth potential of the cryptocurrencies they invest in. They focus on established cryptocurrencies with strong track records and real-world use cases.
• Long-term investment strategies include HODLing (buy and hold), dollar-cost averaging (investing a fixed amount regularly), staking and earning rewards, diversification, and research-backed investments.
• This strategy suits investors who are patient, believe in the future of digital assets, and are willing to hold their investments for extended periods.

Short-term Investment:

Short-term investment in cryptocurrencies involves buying and selling digital assets over brief periods, often ranging from a few days to a few weeks or even hours. This strategy aims to profit from short-term price fluctuations and market volatility. Here are some key characteristics and considerations for short-term crypto investment:

• Short-term investors closely monitor market trends, price actions, and cryptocurrency predictions to make quick buy and sell decisions. They prioritize taking advantage of short-term price movements.
• This approach is faster-paced and more speculative, requiring a keen understanding of market dynamics and quick decision-making skills. It carries a higher level of risk due to the need for precise timing and the potential for losses if predictions are incorrect.
• Short-term investors often use technical analysis, chart patterns, and real-time data to inform their trading decisions. They may employ strategies such as day trading, scalping, swing trading, arbitrage, and news-based trading.
• This strategy suits investors who seek quick returns, have a good understanding of market analysis, and are comfortable with higher risk and more active trading.

In summary, the choice between long-term and short-term investment strategies depends on your financial goals, risk tolerance, and investment horizon. Long-term strategies offer potential for substantial returns over time, while short-term strategies provide the opportunity for rapid gains but carry higher risk due to market volatility. A balanced approach that incorporates both long-term and short-term elements can provide a diversified portfolio and the potential for the best of both worlds.

Tax implications

The tax implications of investing in cryptocurrencies can be complex and vary across different jurisdictions. In general, the profits or income from cryptocurrency investments are taxable, and they are treated as property by tax authorities. Here are some key considerations:

• Capital Gains Tax: If you sell or exchange cryptocurrency for a profit, you may owe capital gains tax. The rate depends on how long you held the cryptocurrency before selling it. In some jurisdictions, short-term capital gains (holding for less than a year) are taxed at your ordinary income tax rate, while long-term capital gains (holding for more than a year) may qualify for a lower tax rate.
• Business Income: If you accept cryptocurrency as payment for goods or services, or if you are a cryptocurrency miner, the value of the cryptocurrency received is generally treated as business income and is taxable.
• Transaction Taxes: Using cryptocurrency to purchase goods or services may trigger transaction taxes, such as sales tax. Additionally, the increase in value of the cryptocurrency between the time you acquired it and the time you spent it may be subject to capital gains tax.
• Retirement Accounts: Investing in cryptocurrencies through a retirement account, such as a 401(k) plan, can have different tax implications. In some cases, gains or losses from cryptocurrency investments made through these accounts may be tax-deferred until you withdraw the funds. However, early withdrawals may be subject to penalties and taxes.
• Reporting and Compliance: It is important to maintain accurate records of your cryptocurrency transactions, including the amount spent and the market value at the time of the transaction. This information is necessary for proper tax reporting and compliance.
• Tax Laws and Regulations: The tax treatment of cryptocurrencies is evolving, and regulations can vary across countries. It is recommended to consult with a tax professional or financial advisor familiar with the specific rules and regulations in your jurisdiction to ensure compliance and maximize potential tax benefits.
• Tax Exemptions: In some cases, certain transactions involving cryptocurrencies may not be subject to taxes. For example, in some jurisdictions, buying cryptocurrency with fiat money, donating cryptocurrency to a tax-exempt nonprofit or charity, or making gifts of cryptocurrency to a third party (subject to gifting exclusions) may not be taxable events.

Security and fraud

As with any financial vehicle, there are opportunities for bad actors to defraud investors in the cryptocurrency market. Cryptocurrency fraud has become a dominant topic of discussion for government enforcement attorneys, with numerous conference panels and agency bulletins addressing its various forms, the hype versus the reality, and the many ways it can facilitate fraud.

Types of Cryptocurrency Fraud

• Scam Initial Coin Offerings (ICOs): Many ICOs are completely fabricated, with phony bios of non-existent team members and technical whitepapers copied from other legitimate cryptocurrencies.
• Pump and Dump Schemes: Owners of a stock try to drive the price up before selling off their holdings at an artificial peak. In the crypto world, this often happens at the ICO stage, whenever false claims can hype up demand and allow the originators or dominant holders of the cryptocurrency to earn massive phony profits.
• Improper Market Manipulation: Fraudsters can attempt to manipulate the markets where cryptocurrencies or related derivative products are traded. Improper market manipulation may include spoofing, front-running, churning, and other schemes.
• Ponzi Schemes: Crypto investments can be used as the vehicle for a traditional Ponzi scheme, where new adopters are necessary to give artificial returns to early adopters.
• Theft: Criminals can hack investors' crypto wallets and steal their currency; they can set up fake wallets to bilk counterparties; and they can set up phony crypto exchanges to steal customers' money.
• Unscrupulous Promoters: The U.S. Securities and Exchange Commission (SEC) famously fined Floyd Mayweather and DJ Khaled for failing to disclose payments they received for promoting investments in ICOs.

Reducing the Risk of Fraud

While it is not accurate to say that cryptocurrency is the new currency of criminals, digital assets have provided another avenue for criminals to conduct illicit transactions. Cryptocurrency's principal features—decentralization, borderless transferability, and a high degree of anonymity—often act as magnets for criminal activity. As a result, legal and compliance teams must be prepared to prevent and investigate fraudulent or illegal activities involving digital assets.

Digital forensics specialists who know where to look and how to navigate this type of investigation can often find, determine ownership, and recover funds in the cryptocurrency ecosystem much easier than can be done for crimes committed using cash and wire transfers. For example, in the case of the Colonial Pipeline cyberattack, $2.3 million in cryptocurrency was recovered.

The emergence of digital assets into mainstream financial services has brought a level of control to the environment, as many of the major players and exchanges must meet Know Your Customer (KYC) and anti-money laundering (AML) requirements. As a first step to regulation, President Biden issued an Executive Order earlier this year outlining the beginnings of a "whole-of-government approach" to digital assets.

To determine whether fraud is occurring within their digital accounts, organizations can employ targeted investigative strategies aimed at tracing assets as they move between digital wallets and exchanges. Investigators may use specialized blockchain forensic tools and traditional forensic methods to search, review, and analyze the origination and transaction activity of digital wallets and cryptocurrencies across their history.

Frequently asked questions