To lower crypto investment risk, the market is starting to diversify

Volatility is nothing new for crypto investors, and 2025 has been a wild ride, with bitcoin rising above $125,000 in October and then experiencing several sharp declines (from peak to trough, falling over $40,000 from its record high).

“Crypto is a volatile asset class, and in a sense there is no way to avoid that volatility,” said Zach Pandl, head of research at Grayscale Investments, a digital currency asset management firm that operates Grayscale Bitcoin Trust (GBTC), one of the largest bitcoin ETFs. “This is an alternative asset class and we are looking for certain return characteristics of it,” he said.

Bitcoin It is currently trading around $88,000, and whether the next move is up or down, investors in the crypto space should have what it takes to stomach the volatility. There may be some help, in the form of new market ideas and classic diversification concepts, to at least protect portfolios from the risky nature of cryptocurrency. These are some of the ideas to consider.

Determine your appropriate portfolio size.

The first step is to make sure your crypto position sizing in your portfolio is appropriate. Some financial advisors are going out on a limb and telling investors to hold up to 40% in crypto. But there is strong evidence that for most investors, cryptocurrency remains only a modest part of a broadly diversified portfolio. This may vary based on an individual’s age, income, risk profile, and other factors, but a good general rule of thumb is to allocate no more than 5% of a well-balanced portfolio to crypto. Despite this, many investors prefer a smaller allocation, generally in the range of 1% to 3%.

Consider reducing the risk level of your other assets.

David Siemer, co-founder and managing director of Wave Digital Assets, an investment advisory firm specializing in digital asset management, emphasized the importance of ensuring that the rest of the investor’s portfolio is aligned to help maintain a comfortable level of volatility. This could mean a lighter tilt in the market’s leading growth stocks in the broader portfolio.

“Because [crypto’s] “If you’re going to either give you rocket fuel or vice versa, you probably want to be a little bit more heavy-handed on the value of stocks or bonds,” he said.

Diversify within the crypto asset class.

Pandl said Bitcoin is the largest digital asset by market cap, but there are many other assets with valuable use cases. Adding risk to a crypto portfolio ether And fade away Cryptocurrency, for example, “can be a way to make sure you’re capturing all those trends in your portfolio,” he said. Pandl added that this approach can increase risk-adjusted returns, just as diversification increases risk-adjusted returns across other asset classes.

Still, investors should recognize that other types of crypto are highly correlated with Bitcoin, so there’s only so much diversification possible within crypto itself, Siemer said.

Other advisors point out that many of the non-Bitcoin digital assets that have become popular still trade like technology stocks rather than stores of value. Investment advisor Nate Geraci, president of NovaDius Wealth Management, told CNBC’s “ETF Edge” program earlier this year that it’s too early to know how the trade will evolve and that risk-on market trading may be more closely tied to the risk-on market than Bitcoin has done over time.

Using Ether as an example, Geraci added, “I see it as a technology play rather than Bitcoin, which many see as digital gold. It takes time for advisors and investors to get used to where it fits in a diversified portfolio. Frankly, it’s too early.”

Buy a range of ETFs or buy into the concept of an index-based crypto fund.

The crypto ETF landscape has expanded significantly since the Securities and Exchange Commission approved 11 spot bitcoin exchange-traded funds in January 2024. Bitcoin and Ethereum spot ETFs have garnered billions of dollars in institutional inflows, and asset managers are actively filing for ETFs covering solana, XRP, litecoin, cardano, and more, with Fidelity Ethereum Fund (FETH) and Solana ETF (SOLZ) being examples.

Pandl said investors should expect many more ETFs to launch next year, providing consumers with additional options and diversification opportunities.

Investors can now also take an index-based approach within ETFs, which is a convenient way to gain diversification in crypto while managing volatility. Grayscale has an index fund called the Grayscale CoinDesk Crypto 5 ETF (GDLC), which launched as an ETF in September and has a basket of the top five crypto assets weighted by market cap. Seventy-five percent of assets as of December 8 were Bitcoin, but this was automatically rebalanced based on market capitalization, Pandl said.

The recently launched Bitwise 10 Crypto Index ETF (BITW) holds 10 crypto assets, including Bitcoin, Ether, XRP, Solana, Chainlink and Litecoin. Cardano is the first ETF that also includes avalanche, sui and polkadot exposures. But like the Grayscale crypto index fund, it’s important for investors to understand that their holdings are heavily weighted towards more established cryptocurrencies. BITW allocates 90% of its assets to Bitcoin and Ethereum.

Use a crypto-friendly financial advisor.

One way to encourage diversification and protect against major portfolio swings is to work with a financial advisor who can help you build a properly diversified portfolio that includes crypto. Not all advisors include crypto in their model portfolios, but this is starting to change as digital assets gain traction.

Tryve Wealth Management, for example, uses Bitcoin as a hedge against the US dollar. Randol W. Curtis, chief investment officer, said if inflation continues at 2.5% to 3%, it would be a significant erosion of the purchasing power of the U.S. dollar. This is where Bitcoin comes into play, Curtis said. “Every year the dollar inflates, each bitcoin will be worth more dollars,” he said. The firm is also exploring Ethereum and Solana platforms, which are primarily used for stablecoins.

Ric Edelman, who runs the Council of Financial Advisers on Digital Assets, told CNBC earlier this year that cryptocurrency’s mainstream adoption phase is happening at a time when investors need to hold more stocks than ever before later in life to achieve retirement income security, and bonds cannot fill the same role as they did in the 20th century. He says cryptocurrency should play a larger role in investing as the asset allocation model moves away from the classic 60% stocks/40% bonds approach.

There are now crypto ETFs that offer an income component to perform some of the functions that bonds do within a portfolio; these include Simplifying Bitcoin Strategy PLUS Income ETF (MAXI) and a planned bitcoin income fund from BlackRock, the world’s largest asset manager.

Cost averaging and rebalancing of the dollar in the crypto market.

Another way to reduce cryptocurrency volatility is dollar-cost averaging, which involves systematic weekly or monthly crypto purchases. That way, you buy at a variety of prices, whether it’s up or down, and that reduces volatility, said Steve Larsen, president of Columbia Advisory Group and co-founder of Certified Digital Asset Advisor.

Larsen also recommends regular crypto rebalancing. He gives a hypothetical example of an investor who holds 5% of his portfolio in Bitcoin, and this ratio increases to 7% depending on the market appreciation. The investor must then sell 2% of their Bitcoin holdings and use the proceeds to purchase other assets. Larsen said that if the percentage of Bitcoin in the portfolio is too small, the investor can buy more.

Advisors have professional tools to automatically rebalance portfolios. Additionally, most major retail brokerages offer their clients rebalancing and trading tools as part of their online account tools. The problem is that many self-managed investors don’t take the time to do this.

“The reason people are amazed by Bitcoin is that they don’t treat it like anything else,” said Ivory Johnson, founder of Delancey Wealth Management. If you had tech stocks and never rebalanced when tech stocks went down, you would be straining yourself. Bitcoin is the same thing. “It’s going up and people think it’s going to go up even more. Treat crypto like any other asset class,” he said.

Johnson points to previous market cycles where investors made risky bets based on unbridled optimism. “There are people who lost their entire savings because they thought there was no way General Motors was going to go bankrupt.” 2009 was one of the largest corporate bankruptcies in US history.

Consider downside protection ETF products.

Some investors who want to get involved in crypto but prefer downside protection may consider a principal-protected bond, which is a financial instrument that returns the principal amount invested at maturity regardless of the price movement of the underlying asset.

Multiple companies offer such products. For example, Calamos Investments launched the first “downside protection” crypto ETF, the Calamos Bitcoin Structured Undercover ETF (CBOJ), in January. Using this strategic approach, the fund company offers multiple ETFs with different levels of downside protection: 100%, 90% or 80%.

Of course, there are management fees associated with ETFs and higher fees for more advanced products. The iShares Bitcoin Trust (IBIT) annual management fee is 0.25%, while the Calamos bitcoin ETF has a 0.69% annual management fee. But some investors prefer to use professional managers rather than investing directly on their own, Siemer said. “For some people, there is value in doing this in a simple product that is easy to buy,” he added.