The Importance of Diversification
Talk to any seasoned investor or follow the practice of large investment groups, and you will see diversification at work. Although trading is never risk-free, diversifying your portfolio brings, on average, more stable results, as there is not just one area of exposure. The phrase “don’t put all your eggs in one basket” is popular for a reason.
When funding liquidity pools, the principle of diversification should also be pursued. Different pairs have varied dynamics and risks, so as well as monitoring positions and studying a token’s history to get a better understanding of its movements, it’s best to divide your capital across different pairs.
In another document in this series, we talk about the correlation between tokens. This correlation may be purely statistical, or because the projects share a fundamental. When diversifying, correlation also plays an important role.
Consider you are choosing to diversify your farming portfolio with REF/USDT and JUMBO/USDT. What could the problem here be?
Ref.finance and Jumbo are both in the DEX space, which brings some correlation. If interest in this area faces a setback, both coins are likely to be negatively affected.
Your LP investment portfolio should incorporate tokens from different sectors, such as those associated with the metaverse, DEXes, blockchain solutions, bridges, stablecoins, and so on. This means that even if one position is affected, others should continue to perform, reducing your overall risk.
While people commonly think of diversification in terms of different cryptocurrencies and the role that they play, there are other forms of diversification that we can consider:
- Blockchain diversification - Do not hold all assets on one network.
- Platform diversification - Hold assets on different platforms.
- Stable coins diversification - Purchase and use different stablecoins.