Risks in Cryptocurrency Investing
Although a part of the new-age tech revolution has been led by blockchain technology, cryptocurrency may be categorized as “risky business”. For starters, cryptocurrency carries a dose of risk when it comes to investing in crypto, which is mostly due to high volatility.
The second risk with cryptocurrency is with the operational nature, meaning that cryptocurrency needs to be safely stored as there are no third parties taking care of the security of your assets, digital wallets and passwords that grant access to your digital wallets where cryptocurrency is usually stored. However, some exchanges offer safe and monitored storage for crypto assets.
The third risk of buying and selling cryptocurrency is regulatory risk, as cryptos are generally unregulated, depending on the government, which may still be working on, or have yet to start working on legal frameworks that would define the use of digital assets.
How are these risks viewed and is investing in cryptocurrency risky? More importantly, how can you manage these risks while operating with crypto and investing in digital assets?
Investing in Cryptocurrency and Top Risks
Some of the main risks when it comes to dealing with cryptocurrency are investing, regulatory and operational risks. However, there are still additional risks related to cryptocurrency investments.
Volatility in the cryptocurrency market is higher than the levels of volatility in other financial markets, such as stocks, for example. This is why the price fluctuates often, and changing trends are a common occurrence in the cryptocurrency and digital asset market. Since volatility is high, the difficulty in price prediction rises, which may bring unpredictable and frequent price swings. Depending on entry points and exits, some traders may take advantage of high volatility and make bigger gains – for example, if you were to buy Bitcoin when the price of BTC was around $7,000, you would be in for major gains once Bitcoin hit $20,000 in December, 2017.
On the other hand, high volatility carries a potential for devastating losses as well as major returns, which is why investing in crypto might have a greater level of risk than investing in stocks, but also bigger returns on the right positions. Some factors that may contribute to volatility include: uncertainty in regulations around Bitcoin and other cryptos, false news and misleading information that slow down the general adoption, fear due to frequent losses in the market, tax treatment and potential security breaches.
Liquidity and Insurance
Bitcoin and other major cryptocurrencies such as Ethereum (the second largest crypto in the market) have a somewhat satisfying level of liquidity, especially as the digital asset market matures and grows more stable. Smaller and lesser known cryptocurrencies have a general lack of liquidity — these assets have major price fluctuations, which makes these lesser-known cryptos a favourable opportunity for collecting bigger gains. However, the liquidity levels seen in smaller cryptos make these assets riskier to invest in as well.
Cryptocurrencies are decentralized and work by its own set of rules.
When it comes to insurance, Bitcoin and other cryptocurrencies are not insured by any government, but instead have a decentralized model of automation, where the system works by its own set of rules that consequently creates insurance for Bitcoin users and BTC. New BTC can’t be issued outside the existing total supply set at 21 million units, making the crypto immune to inflation, which isn’t the case with government-issued money. The human factor in fiat currency issuance can create conditions for inflation as new money can be printed without limitations. Moreover, Bitcoin’s blockchain is created to support the generation of new blocks and thus ensure the overall functionality of the network through the process of mining. Mining provides insurance against double-spending of Bitcoin, all while providing transparency with no central authority.
Manipulations in the Market
Manipulating financial markets is illicit and likewise punishable, which means that price manipulations and manipulation strategies, such as pump-and-dump, are strictly prohibited in the stock market and other similar mature and highly regulated financial markets. When it comes to the cryptocurrency market, this is not the case and investors with substantial net worth can manipulate the market trends to go in their favour with a bit of effort. Whales, i.e. investors with high net worth, are individuals or groups of similarly ranked investors, who tend to manipulate market trends with a final goal of making a profit.
Whales can make a significant change in the course of market trends, making the prices either drop through bear whaling, or rise through price pumping, which is similar to the pump-and-dump strategy considered illegal in other financial markets. Since the market for digital assets is small and immature in comparison to other financial markets, prices are susceptible to sudden changes in trends that sometimes appear as the product of market manipulations.
Security and Custody
You have bought your first units of Bitcoin, XRP, Bitcoin Cash, Litecoin or any other cryptocurrency, which means that you are in charge of your own assets, which includes the security and safety of your crypto investments. While many exchanges specialized in cryptocurrency trading offer crypto storage for account owners, most crypto investors will decide to keep their funds in privately owned digital wallets. Digital wallets are encrypted, but the overall security of your funds greatly depends on what type of digital wallet you are using. When it comes to custody and custodial commitments, you are the one in charge of your funds, as private passwords can grant access to your account. No one will hold your password for you or help you if you lose or forget the password (or private key) for your wallet, as cryptocurrencies are decentralized and no third-party is in charge. Hacking attacks and attempts to steal funds from exchanges and wallets are a common occurrence.
Exchanges are battling against hackers and the theft of users’ funds by upgrading their security systems, but hackers will still try to use attacks such as phishing, cryptojacking and even Slack bots. When it comes to phishing, a hacker is usually targeting new crypto owners through ads and suspicious websites that have no actual value and are spam. They attempt to make a crypto owner reveal some information crucial to accessing their funds. Cryptojacking may be more sophisticated, so to speak, and thus harder to avoid. For example, a clipboard hijack malware was used on one occasion to target over two million Bitcoin wallets in an attempt to replace the copied wallet data with the hacker’s in the process of sending Bitcoin to other wallets. Slack bots can be ignored to avoid falling into a trap that could lead you to lose your crypto wallet. Slack bot attacks robbed many of their crypto units as the bot will appear to notify you about issues with your wallet, offering a link where you would be asked to share your wallet info, revealing your data to attackers.
Regulating Investments in Cryptocurrency
One of the main risks regarding crypto investments is the fact that there is no defined clarity on regulations, tax, legal or financial treatment. That means that institutional investors that are able to bring the “big cash” in are more likely to stay aside as they can’t get a grasp of insurance, liquidity or safety. What might be the bigger problem here is stability – the lack of regulations in all terms listed above give the cryptocurrency market low stability, as the market is still in a way “wild” and immature.
Even though Bitcoin was created in 2009, regulators from all over the world did not bother to define a legal framework for Bitcoin and other cryptos until BTC showed major value potential in 2017. Some countries opposing Bitcoin trading and the overall usage of crypto, and other countries are already looking for investors as they are looking into the potential of blockchain technology, crypto assets and similar tech novelties that arrived with Bitcoin’s issuance.
False News and FOMO
True or false, news spread across the internet at the speed of a wildfire, which is why false news and misleading information can become dangerous to an inexperienced trader. Fear of Missing Out, or it’s better-known abbreviation, FOMO, is also a dangerous phenomenon when combined with money and investments. FOMO and false news regarding cryptocurrency may often affect the price by changing the course of trends as many traders may sell or buy their positions in Bitcoin and other cryptocurrency solely based on headlines on the internet.
These two factors bring up the overall uncertainty ruling the crypto markets, which means that you should always double-check news to avoid falling victim to false news, while also paying attention to technical indicators. It is not strange to see good or bad news regarding a publicly traded company that lowers or increases the value of stocks, which can often happen. The only difference is that manipulations of these types of markets with false news is punishable by law as stock markets and similar investment sectors are strictly regulated by governments.
Emotions as a Factor in Investing
Every investment carries a certain level of risk. Investing in stocks, as well as in cryptocurrency can likewise become a “risky business” if crucial metrics and signals are not taken into consideration. By combining important metrics and research to form technical and fundamental analysis, you are getting ready to become a successful trader or investor. However, there are several more things you need to know when it comes to managing risks in investing.
One of the most effective strategies that are set to guarantee a cool head when considering where to place your entries and exits is managing your emotions. In investing, reducing emotional factors is effective risk management. Emotions can often push us towards accepting risks, instead of avoiding risky investments when driven by logic. Once you are able to decide what kind of trader you are and what kind of trader you want to be, it will be easier for you to predict the possible outcomes of your investments, building a portfolio with success.
f you stick to your emotions, driven by fear, greed or other feelings, you may end up making the wrong moves, which is why you need to be down to earth when investing in crypto and other assets. Once you start investing, you need to be able to track your progress and also learn from your past mistakes. If you are breaking even in your trades, that means that you are fairly good at risk management, but at the same time, you are more likely intimidated and afraid of even the slightest level of risk. That means that you need to reconsider your trading strategy when making entry and exit points.
Managing Risks When Investing in Cryptocurrency
There are numerous risk management strategies you can use to collect gains and limit your losses, usually involving one of the three main strategies for managing risk, which include position-sizing, reward to risk ratio and stop-loss technique.
Position sizing refers to how many cryptocurrency units a trader willing to buy in order to make a profit. By investing between 30 percent and 100 percent of your investment capital, you are making a move that could enable a major cash in on your initial investment, but you are also increasing the risk involved. One of the effective portion-sizing strategies is calculating the entry amount against the risk amount. That means that you are including the value you are willing to invest in crypto against the funds you can afford to lose. The entry amount against the risk amount should provide you with the final result of the ideal amount to invest, while you can also include stop-loss to make a safe exit point.
Consider risk vs. reward ratio and learn from your mistakes
Another useful strategy is to never place your entire investment into a single asset — you should strive to have a diverse portfolio with different assets, which can be especially useful for getting a deeper insight into the market if you are only starting out investing in crypto. Moreover, the riskier an investment is, the more profitable it gets if the trade turns out well. To reduce the risk, traders can use risk to reward ratio, calculating whether you should make an entry point or mark a potential investment as unprofitable. Stop-Loss and Take Profits can help you set up the perfect time to exit by arranging your exit points to match your trading expectations. That way you are able to collect profits and retreat from a trade when the price touches a value that would make you lose your investment. Every trade and investment, within or outside the crypto market, carries a level of risk with it, which is why you should be ready to accept losses and learn from your mistakes in order to be able to make a profit as well.
When it comes to investing in cryptocurrency, you also need to keep in mind that the digital asset market has high volatility, which means that prices may drop or rise all of a sudden, and trends may switch almost unexpectedly. This is the case because the crypto market has yet to mature and become stable. Until a higher level of stability is achieved, it is advisable to diversify your portfolio to address the high levels of volatility, meaning that you should consider investing in several different cryptos, while always looking for ways to minimize your loss. By avoiding making exits and new entries in shorter periods of time, you might be missing out on profit, once again because of a fear of risk –which is why you should dive into the market and adopt technical and fundamental analysis while following historical trends, so you can make profits and reduce the risk involved.