Definition
In the context of finance, diversification refers to the allocation of capital to different financial instruments within and across different asset classes. The main goal of diversification is to reduce the risks involved in holding a single asset class such as a bond, stock, commodity, or cryptocurrency.
Understanding the term
The central concept behind a diversification strategy is based on the fact that a wide variety of assets is more than likely to give long-term gains. Diversification can be achieved either with a single asset class or across various asset classes. A diversified portfolio will have a smoother variation in regards to its net value, as the assets that perform positively tend to neutralize ones with negative returns.
For instance, a cryptocurrency trader may diversify a portfolio by allocating more to stable cryptocurrencies such as Bitcoin and Ether, mixing it with some other types of cryptocurrencies such as stablecoins which can manage portfolio risk. Cryptocurrency traders normally hold a broad variety of coins and tokens which have different use cases, ranging from smart contract platforms to supply chain tokens and more.
Takeaway
Diversification simply refers to a strategy that mixes a wide variety of investments as part of a portfolio. Diversification can be done across asset classes or within a particular asset class, such as cryptocurrencies. While diversification mitigates performance in the short term, it can also eliminate portfolio risk.