“Some risks that are thought to be unknown, are not unknown. With some foresight and critical thought, some risks, that at first glance may seem unforeseen, can in fact be foreseen. Armed with the right set of tools, procedures, knowledge and insight, light can be shed on variables that lead to risk, allowing us to manage them.”
― Daniel Wagner, CEO of Country Risk Solutions
There is a lot of speculation about comparing crypto and traditional finance. I myself have put these two on the scales a number of times. Indeed, the two environments are different in nature, maturity — there are distinctions on many levels. But, when it comes to investment, managing risks is crucial for both. Common risks include the unpredictability of markets: even the calmest trading instrument can surprise. Therefore, you should always be careful and monitor the situation in the markets.
Of course, there are risks that are only true to crypto investments and they distinguish cryptocurrency as a separate asset class. A low level of liquidity leads to excessive volatility, which in turn can carry increased risks for beginners as well as experienced traders. Lack of regulation also leads to additional risk factors for crypto investors. Despite the evolving technology of security protection against intruders, cryptocurrency platforms tend to be attacked. Which is why the possibility of a loss is always there.
Here comes the question: at what point should an investor begin considering risks and ways to tackle them? Risk management should start long before investing or trading. First and foremost, it is essential to determine the amount one is ready to risk and lose. Only fools would risk all their savings. In the world of trading there are certain risk levels that include the trading strategies themselves and these often make up a few percent of the total balance. There are also psychological levels of risk. For instance, you definitely should not continue trading on a day if you have lost more than 10% of your balance.
“Rule number one: Don’t lose money. Rule number two: Don’t forget rule number one.”
— Warren Buffett
Global risks in relation to cryptocurrencies are mainly associated with their legal status and regulation. As blockchain and cryptocurrencies are introduced into the real sector of the economy, these problems will be solved at the governmental level of individual countries and international relations. In the end, the cryptocurrency market will ditch the inactive currency which is uninteresting in terms of value and security.
What is your risk tolerance?
Neoclassical economics suggests that modern financial theory is built upon the concept of homo economicus — the embodiment of rationality and self-interest choosing the best options. The decision-making and selected strategies stem from the risk profile. There are three major types: risk-seeking, risk moderate, risk-averse.
The risk seeking investor hunts for the highest upside plays, and accepts investment uncertainty and great volatility for the sake of higher returns. A risk moderate investor is the one that seeks to actively mitigate downside risks, but also aspires for a decent upside. This type of investor would avoid the majority of ICOs and look for plays backed by serious teams. The risk-averse investor is focused on control of the downside to a far more extent than prospects of high returns.
Intimate dialogue with yourself is the thing I offer to start with. In an unstable environment, different profiles will act differently. You have to figure out your type of profile and have enough discipline to stick to your path and guidelines (even if it takes creating ones of your own).
How to manage?
Now let’s proceed to specific risk management techniques every crypto investor must consider.
Portfolio diversification. If we take a look at traditional financial markets (and we should do that more often) a diversified portfolio is an axiom for an investor. One diversifies a portfolio, not only across asset classes, but also within them. This is exactly the measure against market volatility. An investor has a chance to capitalize on various market movements and stay alive and kicking whatever happens. The crypto landscape is huge and vibrant; there are hundreds of cryptocurrencies to think about. But make sure you do your homework and research the projects thoroughly.
Hedging. This tool is used as a timely response to new patterns on the market that must be taken into account when developing investment strategies. Hedging is applied to mitigate the risks linked with volatility, and provides an opportunity to keep a stable portfolio when market conditions go crazy. Surprisingly enough, crypto exchanges do not seem to have a safe toolkit for hedging existing risks. Kyrrex is the first to introduce hedging solutions for traders which would allow them to benefit from a price increase, earn passive income, and fully or partially compensate for loss in case the price goes down.
Shorting. Basically, this option means betting against an asset. If the price goes down — you win. This is a good move, especially during a bear market, and a nice addition to the trading arsenal. In a nutshell, it is a variation of doubling down. The strategy is very interesting, but I would recommend spending some time learning its nuances — it is complex, it demands that one knows the markets. Moreover, the technique implies a certain psychological type and risk profile.
Long / Short positions. When an investor takes a long position on a certain asset, he or she buys it outright. What I mean by that is one owns the stock and the chance of profitability depends on its value increase. One closes the position via selling the entire asset amount at a higher price. Ultimately, an investor automatically returns the amount of cash borrowed from an exchange, and at the same time keeps the profit from assets. Opening a short position, in contrast, means you borrow an asset and expect the value to decline. To close a position an investor buys back the entire asset volume at a lower price. Again, one automatically returns the amount of cash borrowed from an exchange, and at the same time, keeps the profit from assets. Why go for long/short positions? You can benefit from price fluctuations that exchange one another throughout the year.
Strategy over emotion. This is about the discipline I mentioned earlier in this article. The most dangerous thought an investor can think — this time it will be different. No, it will not. There are patterns, cycles, history repeating itself — all of this implies strategies and commitment to them. Certain trends can easily get you engaged in different projects, and immediate emotions have nothing to do with the investor’s gut feeling.
Now a few tips for aspiring investors.
● Trading and investing should always be cold-headed. You should never get into the excitement if there is any level of losses you have set for a certain period.
● Know when to stop: you should cease trading for that period if the “red” level has been reached and then continue trading, for example, the next day.
● If you entered a transaction with the calculation of profitability and loss levels, you should not change the terms of the transaction, if suddenly the price moves not in your favor. Accept the potential loss, get over it and keep working with other open transactions.
As you can see, this writing is dedicated to market volatility and all the relevant measures to be taken. A bunch of other risks include sporadic regulation, insufficient custody solutions, cybersecurity, reputational and brand risks. Make sure you work with regulated, credible and trusted crypto exchanges — a large portion of risks will simply fall off.