Diversification: Sound Action Plan or Overhyped Illusion?

Investors debate diversification for balancing risk and return, with a focus on safeguarding Bitcoin holdings from theft or loss.
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This article is sponsored by Meanwhile

Diversification has long been a subject of discussion among investors debating the costs and benefits of balancing risk with return. In the world of Bitcoin, the discussion extends to safeguarding bitcoin holdings against theft or loss. Meanwhile, a pioneering life insurance company denominated entirely in bitcoin offers a novel approach to diversification that might be essential for Bitcoinization to take place.

What is Diversification?

Diversification is an investment strategy aimed at spreading risk across a variety of assets within a portfolio. The principle behind diversification is to reduce the overall risk of the portfolio by investing in different types of assets that are not closely correlated with each other.

Investors achieve diversification by investing in different asset classes, such as stocks, bonds, real estate, etc. It’s possible to achieve further diversification within each asset class by investing in different sectors, industries, regions, and types of securities.

The goal is to create a portfolio that is less susceptible to the impact of any single investment’s performance or market conditions. While it doesn’t eliminate risk entirely, it’s especially useful for mitigating risk over long periods.

Is Diversification a Good strategy?

Whether or not creating a diversified investment portfolio is a good idea depends entirely on your skills as an investor. At its core, diversification is protection against ignorance. Warren Buffett, perhaps the most famous investor in history, said, “[Diversification] is a confession that you don’t really understand the [stocks] that you own.”

According to Buffett, investing in a diverse portfolio, like an index fund, is a great idea if you don’t know what you’re doing. It protects you from risk, meaning your wealth will grow with the stock market. Since the stock market grows steadily over several decades, people who invest once and simply hold the investment until retirement tend to perform better than day traders who try to time the market.

Over the long run, day traders tend to underperform border market returns due to their poor decision making criteria. This is driven by their inability to accurately manage their biases and emotions. Skilled investors are not day traders. They perform deep due diligence on a company and invest as much as possible into that specific company if they believe it will be successful.

This is how Warren Buffett built his wealth. In his own words, “There aren’t that many wonderful businesses.” So investing in one, two, or three “wonderful businesses” is better than investing in 10 to 20 businesses, most of which will not be very successful.

Michael Saylor summed it up best: “Diversification is selling the winner to buy the losers.”

How Does Diversification Apply to Bitcoin?

Bitcoin shouldn’t be thought of like a stock. It’s not a company you invest in. Bitcoin is money.

If you live in the United States, you probably haven’t “diversified” your currency holdings. You likely own U.S. dollars and that’s it. That is, of course, unless you also own bitcoin, which means you probably use dollars in your daily life and HODL bitcoin for the future.

One can achieve diversification not only by holding a variety of types of currencies, but also by holding a specific type of currency for different purposes. For example, you probably have dollars in your wallet in the form of cash. You probably have some in the bank in a checking account. You probably also have a savings account. Maybe a retirement plan you’ve invested into. Maybe an investment account. Maybe a trust fund.

Although these are all denominated in dollars, the manner in which you hold or utilize those dollars is diversified across purposes. This can (and should) also be applied to bitcoin. Now although bitcoin is currently primarily used as a store of value, there aren’t as many mechanisms to hold it productively as there are with dollars. However, that could be changing.

Why You Should Diversify Your Bitcoin Holdings

With fiat currency, diversifying where your currency is stored is directly correlated to how it’s being used. If it’s money I want available to me on a daily basis, it goes into the checking account. If I want to put it away for a rainy day, it goes into the savings account, and so on.

With bitcoin, the primary reason to diversify is asset protection. Storing all of your bitcoin in one wallet means you’re vulnerable to losing your entire stack if that wallet is compromised. For example, Rick Messitt had a 25 BTC stack that he had built up over 10 years stolen when his father’s laptop was hacked.

As Rick himself said in an interview, “If you want to be your own bank… you can only have those benefits if you also take on the responsibilities that come with being your own bank.”

So storing your holdings in multiple wallets is a good idea for hedging against theft or loss because losing one wallet doesn’t mean losing your whole stack. For example, you might store most of your bitcoin in a cold storage wallet which you keep in a secure physical location. At the same time, you might keep a small amount on the Lightning Network that you can use in transactions. You might also have some in an online wallet, such as a mobile wallet, so you can still transact on the Bitcoin mainnet.

In this way, you can diversify your bitcoin storage similarly to how you diversify your fiat storage, both for security and ease of use. What has been lacking in the Bitcoin space until now are more advanced financial products allowing people to invest their bitcoin holdings in the same way they can with fiat.

However, new opportunities are arising.

Meanwhile and Bitcoin Insurance

Meanwhile is a life insurance company entirely denominated in bitcoin. That means its premiums are paid in bitcoin, its claims are paid out in bitcoin, and customers can even borrow against their policy value in bitcoin.

Perhaps surprisingly (or perhaps not, knowing the Bitcoin community’s aversion to traditional finance), Meanwhile is the first and currently only insurance company in the world entirely denominated in bitcoin.

And since life insurance premiums comprise roughly 2-3% of national GDPs in developed countries, there’s a huge gap in the market here to get capital into the Bitcoin Network and bring the decentralized currency to the masses.

Putting all your bitcoin onto hardware wallets and burying them in the backyard or locking them away in safes isn’t necessarily a terrible idea, but it’s not the best idea. You wouldn’t do that with the currency that you use day to day, and that’s what Bitcoiners are hoping bitcoin one day turns out to be.

For bitcoin to become ubiquitous, the functionality of traditional finance needs to be there. For now, Meanwhile is the only game in town.

Using some of your stack to pay BTC premiums for life insurance does several things simply HODLing does not:

  • Meanwhile pays out more BTC in claims than it receives in premiums, growing your stack.
  • Life insurance is tax-advantaged, and in the case of Bitcoin, is not subject to capital gains or income tax.
  • Meanwhile allows you to borrow against your policy value, enabling individuals to tap into the liquidity of their policy during their lifetime by borrowing BTC out of it. Policy loans in whole life insurance are also tax-advantaged.
  • Unlike handling bitcoin on a hardware wallet, which lacks regulatory oversight and expertise, relying on a life insurance company offers a safer and more reliable means of ensuring the seamless transfer of assets to beneficiaries.

The issue with this model is exactly the same issue people have with traditional finance and their fiat holdings: counterparty risk. Meanwhile is custodial in nature, and it achieves its obligations of paying out more bitcoin than it receives in premiums by rehypothecating and lending its bitcoin.

Similar to Rick’s warning about being your own bank, if you want the benefits of traditional finance, you must accept the risks of traditional finance. Many Bitcoiners might not be willing to accept these risks, but they should consider how Bitcoinization can ever take place if these financial products and services are never made available in bitcoin.

Conclusion

Diversification can mean different things depending on the context. In an investment context, it means investing in multiple companies, industries, etc. that are non-correlated (they don’t affect each other and they aren’t affected by the same things).

Diversification is a good idea for people who don’t know what to invest in, typically people who don’t have the expertise to analyze companies. If you do know what to invest in, it’s best not to diversify. Double down on what you believe is a good bet.

Diversification in the context of bitcoin refers to increasing the number of ways you store or invest your bitcoin. This is done to limit the amount of bitcoin you could lose either through mismanagement or theft.

Bitcoin should ideally be diversified in a similar manner to fiat currency, for both security and ease of use purposes. Meanwhile is the first and only life insurance company entirely denominated in bitcoin. It gives people the option to diversify their bitcoin holdings by growing their stack and storing their wealth in a tax-advantaged manner that they can then pass onto their beneficiaries.

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