Cryptocurrency investing includes more than just bitcoin and ether, but with over 10,000 tokens available to investors, how does one select which currencies to hold?
In a series of blog posts we will seek to outline the case for investing in a diversified portfolio for cryptocurrencies by exploring the concentration of the cryptocurrency market, the benefits of diversification, index construction and selection criteria designed to minimize risk. We will kick off the series with a discussion of the concentration of the cryptocurrency market.
Historically cryptocurrency markets have been dominated by bitcoin which also has the distinction of being the oldest, largest and most widely known. Following its launch in 2015, ether quickly gained prominence and moved into the number two spot after only 6 months. Since the beginning of 2016 bitcoin and ether have dominated the cryptocurrency markets and the public discourse surrounding crypto investing.
As recently as March 2022, bitcoin and ether comprised nearly 90% of the cryptocurrency market. I think it’s important to clarify that we are focused solely on cryptocurrencies and have excluded stablecoins and asset backed tokens from this analysis.
Source: CF Benchmarks, as of March 1, 2022
The dominance of bitcoin and ether in cryptocurrency markets can be attributed to a number of factors but the foremost of which is the infancy of the space in general. The average age of all constituents in the index is only 5.75 years. When you remove the largest, that average age falls to only 4.75 years.
Each cryptocurrency network is supported by miners, node operators and users. Bitcoin, which is now over 13.5 years old, has had more than twice as much time as the average constituent to establish a network effect of participants. Since its inception, the bitcoins blockchain network has accumulated 37.5 million active non zero addresses. By comparison, the smallest constituent in the index which, coincidentally is the same age as the average age of all the index constituents, has accumulated only 130k active non zero addresses. (Source: Glassnode, July 18, 2022)
These smaller networks add diversification by gaining exposure to new and innovative technologies that strive to improve upon the existing experience users have in bitcoin or ether. While their technology is not as revolutionary as bitcoin, they are no less disruptive and can add diversification.
Tomorrow we will further expand on the benefits of diversification, even in an asset class that has experienced high historical correlations.
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