The Case for Diversifying Your Cryptocurrency Portfolio Across Multiple Exchanges
TLDR: At HodlBot, we are launching new integrations which will enable our users to diversify their assets across multiple cryptocurrency exchanges. If you’re looking for a simple guide on how to set-up HodlBot with Kraken, check out this tutorial here.
We started HodlBot in March 2018 with the goal of democratizing cryptocurrency investing for everyday people.
A year after we launched, we’ve helped 10,000+ users diversify over $50 million USD.
Our MVP was a simple trading bot that plugged into Binance. It automatically diversified your cryptocurrency portfolio across the top 20 coins by market cap. We’ve come a long way since then. Users are now able to create their own custom portfolios and custom indices.
But there’s still one thing that bothers us and is still a pain point for our users. And that is exchange risk — the potential risk of losing your assets on a compromised exchange.
While we were able to help users diversify their portfolios across various cryptocurrencies, we were not able to help users diversify their assets across multiple exchanges, until today.
Diversifying Your Risk Across Cryptocurrency Exchanges
Centralized exchanges are not invulnerable. They can be hacked or mismanaged. In the worst case scenario, corrupt exchanges may defraud their users.
But even in 2019, we can’t get away from the fact that centralized exchanges account for the significant majority of cryptocurrency trading volume. Decentralized exchanges make up less than 0.1% of total trading volume on any given day.
People use centralized exchanges even in spite of the underlying risks they possess because they work really damn well. Centralized exchanges have terrific liquidity and low transaction costs. So moving completely off of them isn’t a realistic suggestion for investors who want to quickly execute trades at good prices and low fees.
Yet, accepting the risk and doing nothing about it isn’t a great option either. No one knows when and where the next Mt. Gox might happen. While we can do our best to only trust reliable exchanges with strong track records, the cryptocurrency world is highly unpredictable.
So if you want the best of both worlds, what is a good solution?
We think the answer isn’t to move off centralized exchanges entirely, but rather to diversify your assets across multiple exchanges.
If one exchange breaks down, the damage is likely to be contained to that exchange. If you’re diversified across many reputable, secure exchanges, you should be able to shield the majority of your capital from exchange risk.
That’s why we’re making exchange integrations a big priority for us at HodlBot in 2019.
Our primary objective to make it simple for investors to diversify their assets across multiple exchanges.
Our belief has always been that the most useful tasks HodlBot can automate for you, are the ones that you would have otherwise manually completed yourself anyways.
Is it possible to index by hand? - Yes of course.
Is it possible to reconstruct the same portfolio across multiple exchanges, and to manage all of their rebalancings manually? — Yeah, but it quickly becomes way too time-consuming.
Fortunately, HodlBot can help you automate all of this.
Select or create a portfolio you want, connect the exchange accounts you own,and HodlBot will execute the required trades to construct your target portfolio across every single exchange.
Why Use Centralized Exchanges at All?
The dream is getting to a point where decentralized exchanges are so great that centralized exchanges no longer have any advantages. Today, that point is a very long way off, and we’ll need centralized exchanges to get there.
You have to build the bridge before you can burn it.
— Jesse Powell CEO @ Kraken
We built on top of centralized exchanges because we felt like it was the only way we could achieve these three things:
- Provide users to full control over their assets
- Enable users to own their underlying assets directly, instead of some tokenized abstraction layer.
- Obtain favourable trading prices by providing users access to liquid markets with low transaction fees.
Full control over their assets
Although the exchange takes custody of the assets, users have full control as to whether they want to buy, sell, hold, or withdraw their assets.
Unlike funds, users can create highly customized portfolios, and enter or exit the market at any time.
We felt that this was extremely important as it empowered users to create the kind of portfolio that matches their individual investment preferences, rather than being forced to adopt a one-size fit all, cookie-cutter, solution.
Owning the underlying assets
We believe it’s very important for users to actually own the underlying crypto-assets themselves. It’s very easy to have fractional ownership of cryptocurrencies, so there is no need to use funds or tokens as an abstraction layer.
Obviously, cryptocurrency exchanges custody the assets. But, nevertheless, we felt that was significantly more favourable than having users own these assets via some tokenized representation à la C20, Coinbundle
Adding an abstraction layer introduces a secondary layer of liquidity and counterparty risk. When you own a tokenized version of your assets, you are still reliant on the counterparty to securely custody the underlying assets. You need to trust in the fact that you can instantly redeem the underlying assets at market price.
But as we saw with Tether and USDT, this is not always the case. In reality, the counterparty often charges you a fee and gives you a long delay before you can redeem your assets. And if these tokenized assets are tradeable, the market may place an illiquidity discount, which values the token below the market price of the underlying assets.
Exchanges also possess counterparty risk, but we believe diversifying across reputable, secure exchanges good track-record is preferable.
Favourable trading prices & liquidity
The reason why large centralized exchanges dominate the market is that they are highly liquid, easy to use, and have very small transaction fees.
Slippage, latency, and transaction cost very quickly turn a profitable strategy into an unprofitable one.
Common strategies like rebalancing are just not as feasible on exchanges like shapeshift, which charges a significantly higher fee and provides much more unfavourable prices.
Centralized Exchanges Are Not Built the Same
We want to be clear that our strategy is not simply to just add a bunch of random cryptocurrency exchanges integration and call it a day.
We’re making sure that every exchange we add passes our strict standards.
- A highly liquid exchange that ranks across the top exchanges by trading volume. (We avoid exchanges that report fake trading volume numbers).
- Long operating history and history of doing right by their customers.
- Reliable and well-documented API for trading.
- An insurance and/or contingency plan for exchange attacks and mishaps.
- Low trading costs.
While we only support Binance and Kraken today, our plan in the future is to support every single cryptocurrency exchange that meets our strict criteria.
While we’re enabling users to integrate multiple exchanges, we’ll still keep the HodlBot experience simple for users who are happy connecting to only one exchange.
If you only connect one exchange to HodlBot, you will not see anything out of the ordinary.
But if you connect more than one exchange, you’ll be able to see exchange options pop up on the main navigation bar.
Each exchange integration can be considered its own separate, sub-account. For example, actions affecting assets in Binance will not affect assets in Kraken and vice versa.
About the Author
I quit my job recently to start HodlBot.
We created HODL10, HODL20, HODL30 indices and the first ever application that allows you to create your own personalized cryptocurrency index fund.
To get started all you need is a
- Cryptocurrency Exchange Account
- $200 in any cryptocurrency