NFTs are an extremely risky asset class, and it is impossible to know exactly what the future will hold. Diversification is a practice that aims to mitigate unsystematic risk (risk unique to a specific company, industry, etc.) by mixing different asset classes and the subsequent classes inside of each. This is done by combining assets that are not highly correlated into one portfolio, essentially “smoothing out” the overall return.

An easy way to think of diversification is this: if you put all of your eggs into one basket and that basket fails, you’ve lost everything. By putting your eggs in multiple baskets (diversifying) you are limiting the risk you will face if one or two baskets fail.

One example of diversifying an equity security portfolio could be holding international, large-cap, and small-cap securities. You can diversify your overall portfolio by holding real estate, precious metals, equity securities, crypto, bonds, cash, and more.

There are countless ways to diversify a portfolio, all with the common goal of limiting risk.

Pros and cons of diversification

Just like with every investment strategy, there are multiple pros and cons to diversification.

The biggest argument in favor of diversification for many is that it reduces risk in your portfolio. Building off of the basket of eggs example above, let’s say you invest all of your available money into a new NFT project and in a few weeks the project’s floor (lowest price of any NFT in a certain category) has fallen 90% and the founders have gone silent. This was an extremely risky investment that didn’t pay off, and you lost 90% of your investment. Now, let’s say that instead you took that money and invested 20% of your total funds into 5 different projects that you liked. Two of them lose 50% of their value, one didn’t move at all, and the other two go up 50%. By putting your money into a variety of “baskets” you reduced your overall risk and are in a much better position than the first scenario.

As you can see pictured above, there are also a few cons to diversifying your portfolio. It can be burdensome and time-consuming to monitor a variety of different asset classes over a long period of time. In addition, short-term gains are limited due to the smoothing of your overall returns. Many people are actually okay with this as downside risk is decreasing the same time

Many investment professionals and advisors consider the pros to outweigh the cons.

How can I diversify an NFT portfolio?

There are a number of different ways to do this, and as the NFT/crypto space continues to expand so will diversification opportunities. NFTs themselves are a new investment class and have a variety of sub-classes inside of their initial capacity. I’ll cover 3 areas inside of NFTs that I consider when looking to diversify my own portfolio.

Remember that the purpose of this material is to provide general knowledge and does not constitute investment advice.

Diversification by currency

Those in the NFT space know that the Ethereum blockchain has been dominant for as long as NFTs have been around. But this isn’t the only chain that supports NFTs. You can purchase NFTs on Ethereum (ETH), Solana (SOL), Cardano (ADA), and more! Just because the Ethereum blockchain is the most popular right now does not mean that will always be the case.

The NFT space is still very young and it’s impossible to tell if Ethereum will continue to be the top dog. It could be beneficial to purchase NFTs on a different blockchain, thus spreading out your reliance on just one chain to succeed.

Diversification by utility

One of the most popular use-cases for NFTs is utility. I previously published an article on different utility benefits that NFTs can provide, which can be found here! To briefly summarize this article; Utility goes beyond just owning an NFT. Holders can benefit in a wide variety of ways. Access, limited merchandise, and ticketing are just a few ways that an NFT can provide utility for the holder. Many collectors are drawn to this space because of this concept, and you can also use it to diversify your NFT portfolio. You can hold tokens that provide you access to in-person events such as VeeCon, merchandise drops that happen throughout the year, or a mint pass that allows you to purchase upcoming NFT drops.

By “betting” on a variety of different types of utility you are shielding yourself from the increased risk of holding just one type of token. For example, when the COVID-19 pandemic hit the globe, many people were stuck inside their homes. If you held a VeeCon ticket that year (VeeFriends had not been created yet, this is just for the sake of the example) and the conference didn’t end up happening, the value of your NFT could go down. On the other hand, it’s possible that tokens that provide access to strong online communities (BAYC, locked Discord channels, etc.) would increase in value as people can have that accessibility from the comfort of their homes.

Diversification by aesthetic

In a category that I have coined to be “diversification by aesthetic”, what I am referencing is the visual aspect of each NFT (essentially art). There are many examples of this such as paintings, generative art, and photography. The list goes on and on, and you can find a wealth of talented artists with a variety of different specializations.

Art as an investment is normally seen as a long-term play. Many artists do not become popular overnight and it can take many years to command the respect they deserve. Physical art is seen as something that can be passed down from generation to generation. NFTs solve a problem in this world, as digital pieces will not be subject to aging or outside elements. By investing in an artist, you are relying heavily on their passion, drive, and ultimately their ability to market themselves. Many would argue that the price of an art piece leans more on the artist who created it, rather than outside factors. That being said, it is important to remember that outside factors are always in play.

Are these the only way to diversify an NFT portfolio?

NO.

There are countless ways to diversify and the deeper you dig the more you will find. I’ve chosen to highlight some of what I believe to be the most popular ways that are currently trending in the NFT space. But this won’t be true for everyone. Not everyone values utility as much as they value art, or vice versa. You must find the balance that YOU want in your portfolio. There is no right or wrong way to do so either, everyone and their portfolios are different! The most important thing is finding a balance that has you loving and feeling comfortable about your investments.

Disclosure: NFTs are a very high-risk asset class. Diversifying your portfolio does not completely mitigate risk. This article is for general knowledge and is not investment advice.