In the context of financial markets, diversification refers to allocating capital to different financial instruments within and across asset classes. The main goal is to reduce the overall risks that may arise from holding a single asset class, such as a stock, bond, commodity, or cryptocurrency.
The idea behind the diversification strategy is that a portfolio made of a wide variety of assets is more likely to give better long-term returns, while also reducing the probability of significant losses. Diversification can be achieved within a single asset class (e.g., investing in different types of cryptocurrencies) or across various asset classes (e.g., investing in cryptocurrencies, stocks, and commodities).
In general, a diversified portfolio will have a smoother variation in regards to its net value. Mainly because the assets that present a positive performance tend to neutralize the ones with negative returns. As such, it is important to consider the correlation between the assets that make up an investment portfolio. For instance, if a portfolio is made up of highly correlated cryptocurrencies, it will react to market influences much like a single-asset bag. Negatively correlated assets are more beneficial in terms of diversification because they respond differently to market forces and tend to move in opposite directions.