The Portfolio Question: How Many Cryptocurrencies to Own?

As you build out your crypto holdings, a question that often surfaces is the optimal number of cryptocurrencies to own. Is there a magic number? We find that looking at the diversification benefit and the associated tracking effort offers a clearer perspective than aiming for a specific count.

The Diversification Benefit

Diversification is a core concept in investing. The idea is to spread your capital across different assets so that the poor performance of one doesn't disproportionately harm your overall portfolio. In theory, owning more assets means better diversification. However, in practice, this benefit diminishes if the assets you add move in a similar fashion to those you already hold. This is what we call correlated assets.

Consider Bitcoin and Ethereum. Historically, these two digital assets have shown a tendency to move in the same direction. If you hold both, and the crypto market experiences a downturn, both Bitcoin and Ethereum might fall in value around the same time, and by similar amounts. Adding, say, Cardano or Polkadot, which also often track Bitcoin's price movements, might not significantly enhance your diversification in the face of such market events.

The diversification benefit is highest when you own assets that have low correlation. This means their price movements are not strongly linked. For example, the price of gold might move independently of the stock market. In the crypto space, while many assets are still emerging and their correlations can shift, the primary drivers of the market often affect a broad swathe of digital assets simultaneously.

The Tracking Effort

Beyond the diversification benefit, there's a practical cost to holding many different cryptocurrencies: the tracking effort. Each asset you own requires some level of attention. You might want to monitor its price, understand significant news or developments related to its project, and review its performance against your expectations.

Imagine you hold 50 different cryptocurrencies. Even if each position is relatively small, managing and monitoring all of them can become a significant undertaking. This can lead to what's sometimes called over-diversification, where the sheer number of holdings makes effective management difficult, potentially leading to missed opportunities or overlooked risks.

For instance, if you have 20 positions, each representing 5% of your portfolio, and one of them experiences a sudden, significant problem, you might catch it. If you have 100 positions, each representing 1% of your portfolio, a similar issue might be harder to spot amidst the noise of managing so many individual assets.

Professional Thinking and Crypto

In traditional finance, a common range for the number of individual stocks in a diversified portfolio might be anywhere from 20 to 60. This number is often a balance between achieving a meaningful diversification benefit and keeping the tracking effort manageable. Professional money managers often have teams to handle research and monitoring, allowing them to oversee larger numbers of holdings than an individual investor typically can.

When we look at the crypto space, the situation is more fluid. Many cryptocurrencies are still in their early stages, and their long-term viability and price behavior are less established than that of public companies. This volatility and the rapid pace of development can increase the tracking effort required.

If we consider a hypothetical scenario: an investor holds Bitcoin and Ethereum, representing 70% of their digital asset portfolio. They are considering adding Solana and Cardano. If analysis shows that Solana and Cardano have a high correlation with Bitcoin and Ethereum, adding them might increase the number of coins they own but offer only a marginal diversification benefit. The added tracking effort for these new positions would then need to be weighed against this small potential gain.

Alternatively, an investor might hold Bitcoin and a small allocation to a basket of smaller-cap altcoins. The diversification benefit here might be higher if these smaller coins have different drivers than Bitcoin. However, the tracking effort for each of these smaller positions would be substantial, and the risk of any one of them failing entirely could be significant.

The decision on how many cryptocurrencies to own is personal. It involves considering what level of diversification benefit you seek and what level of tracking effort you are comfortable with. There isn't a single correct number. It's about finding a composition that aligns with your capacity for research, monitoring, and your tolerance for complexity.

What is over-diversification in crypto?

Over-diversification in crypto occurs when a portfolio holds so many different cryptocurrencies that the management and monitoring effort becomes burdensome, potentially diminishing the benefits of diversification. It can mean that individual holdings are too small to have a significant impact, positive or negative, and that the investor's attention is spread too thin to adequately assess each asset.

How does correlation affect diversification?

High correlation between assets means their prices tend to move together. If you own many highly correlated assets, adding more of them provides little additional diversification benefit because they are all likely to react similarly to market changes. True diversification comes from owning assets with low or negative correlations.

Is there a maximum number of crypto assets to own?

There isn't a universal maximum number. The ideal number depends on an individual's resources, expertise, and risk tolerance. For many individual investors, holding a smaller number of well-understood assets might be more manageable and effective than attempting to track a very large, highly diversified crypto portfolio.

We wrote this to explain, not to recommend: treat it as information, not advice.