The crypto industry has proven itself to be very innovative and diverse. At any given time, there are thousands of tokens floating about the space that can be bought from crypto ATMs, exchanges, and others. On the upside, it means that there is no shortage of tokens that you can invest in if you want.
The downside of this is that you could end up being overwhelmed by choice. While you can also ways count on an expert team to provide content on the best cryptos in the market, a classic investment strategy called factor investing can also prove helpful.
Factor investing is an investment approach that has an investor target assets with certain factors to ensure the best returns. It is usually used in the context of stocks but if applied to crypto, it can help you sort through the endless options in the market. Here are some of the factors to consider:
Size
The first thing to consider is size. In the context of investment, size would refer to market capitalisation. As per the rules of factor investing, assets with lower market caps are believed to perform better than those with higher market caps. One of the reasons for this is that because they have low market caps, price rallies can be triggered more easily and with smaller amounts.
Say you invest in a crypto with a market cap of a few hundred million. It would only take one whale investor buying several million of stock or a major institutional investor buying into it to make the price go up. Similarly, the slightest whiff of mainstream acceptance can send a smaller crypto into a price rally and this benefits those who invest in it.
Compare this to a major token like Bitcoin that would need concerted efforts of a large chunk of the market before it would experience a price rally. A few million worth of crypto being bought will not trigger a bull run by any means. So, as you diversify your portfolio, you might want to add tokens with smaller market caps that have a higher chance of entering bull runs with ease.
Momentum
Momentum, in this case, refers to buying assets that have seen an impressive medium-term performance with the expectation that this will continue into the future. In the context of crypto, this would mean buying tokens that have been performing well already. The idea is that they will continue to perform well and thus, catch the attention of other investors and as they buy into the token, its price will only continue to go up.
There is historical evidence to support this but it isn’t a hard and fast rule. Tokens see a slowing of their momentum all the time and pump-and-dump schemes are still something to be wary of.
That being said, it might still be a good idea to include tokens with momentum in your portfolio. Many crypto price trackers allow you to filter by the biggest earners over the last day, week, month, and so on. Leveraging these tools would be a good way to find promising tokens to invest in. You also want to keep your ear on the ground by following crypto-related media. This way, you can see stories about tokens generating buzz in the market.
By doing this, you can get a sense of which tokens might have momentum and thus, might be good investments.
Volatility
According to the principles of factor investing, assets with lower volatility tend to perform better than those with higher volatility. The idea is that investors should fill their portfolios with assets that are low-volatility and over time, they will match typical market returns without the investor having to deal with unpredictable asset behaviour.
Applying this idea to the crypto sector, however, is rather tricky. Cryptos are known to be quite volatile as an asset class and some of the most volatile like Bitcoin are still the most valuable in the market. This does not necessarily mean that this principle is wrong or shouldn’t be applied.
Even within the crypto sector, some tokens are known for having lower volatility and you should make sure that they are included in your portfolio. Crypto exchanges and price trackers have tools that rank tokens according to volatility and these can help with token discovery.
While these tokens might not see the dramatic price spikes of a Bitcoin or an Ether, they are likely to bring in consistent returns, which is what you want at the end of the day.
At the same time, you might still want to invest in some tokens like Bitcoin that, while volatile, could make up for the trouble over time.
Quality
When discussing investing, the word quality is brought up a lot. This also applies to factor investing as investors are advised to prioritise assets that are linked to ‘quality’ companies. In this context, quality companies would be those with healthy balance sheets and cash flow. The idea is that the quality of these companies means that their stock will continue to deliver healthy returns.
If you’re investing in crypto, you should also look for quality projects and tokens, though the parameters might be different. Cryptos attached to projects and entrepreneurs that have been in the market for a long time and have developed a positive reputation would be good candidates. Cardano, for example, was founded by the same developer who helped to create Ethereum. That would be an indicator of the token being a quality one. In terms of longevity, cryptos that have been in the market for a significant amount of time and have proven their quality would be considered to be good quality as well.
Intangible Value
When factor investing, investors are told to choose assets that carry a high amount of intangible value. Intangible value refers to the value that an asset has that isn’t tied to physical use. If you have a tangible asset like a piece of equipment or a factory, its value is pretty obvious. However, intangible assets like stock also have value and should be added to an investment portfolio.
The same applies to cryptocurrency. While cryptocurrency does not have value in the way a piece of equipment does, many tokens are still valuable. Many tokens are used with specific ecosystems, can be used to tokenize assets, and so on.
This is a major factor that should guide your choice of tokens to invest in. Ask yourself what use cases the token has. Some might be an ideal replacement for fiat currencies, like using Bitcoin for gambling at cryptocurrency casinos, or using Ripple (XRP) for cheap and fast international transfers. This will determine whether there will be long-term use of the token and thus, if it will retain its market value over time.
Conclusion
For the average crypto investor, the endless variety in the market can be overwhelming. Luckily, they can always turn to factor investing, which has been guiding investment decisions for the last few decades. This system highlights the things that people should look for when they are trying to choose assets to invest in.
From considering the market size of an asset to the intangible value it might have, factor investing can help you separate the wheat from the chaff. Soon, you’ll have a diverse crypto portfolio that will deliver healthy returns year in and year out.
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