Cryptocurrency trading is often considered risky mainly due to its volatility. The crypto market can experience extreme price swings and there is a chance that your investments may lose their value, regardless of how promising the project may be.
Considering these factors, it is crucial to employ risk management strategies when investing in or trading cryptocurrencies. Today we will look at some of the common risks involved with cryptocurrencies and strategies you can practise to better manage those risks.
So let’s get started.
Risks of Cryptocurrencies
It is important to educate yourself about the possible risks involved with cryptocurrencies. Here is a list of considerations to get you started.
Volatility is synonymous with crypto assets. This nature makes cryptocurrencies unpredictable, meaning they change price quickly and can reach a record high at one moment and immediately fall to their lowest lows in the next.
Government regulations surrounding crypto assets are constantly evolving and can differ from jurisdiction to jurisdiction. Regulations can affect how you use or access your crypto assets. Tougher rules can even cause volatility or regulatory uncertainty. This is because the asset class is relatively new and lawmakers are still working to establish clear and consistent guidelines.
Scams and Lack of Legal Protections
Cryptocurrency platforms are always susceptible to fraud. While most crypto applications have enacted stringent security systems, some platforms are lapse and can fall victim to bad actors. Another issue is that there is no protection or insurance offered for lost or stolen cryptocurrencies.
When it comes to storing cryptocurrencies, there are two ways: in a non-custodial cold wallet, or by trusting a third-party custodian. When storing privately, you will be the sole person responsible for safeguarding your crypto. If you happen to lose your private keys, your device crashes, or a virus corrupts your wallet, then there is no way to recover your funds.
Whereas in the case of centralized platforms, you are trusting them with your crypto and if something were to happen to your custodian, then you risk losing all your assets.
Crypto Risk Mitigation Strategies
Below are a few ways in which you can better manage risk when trading cryptocurrencies
Only Invest What You Can Afford to Lose
As is the case with any type of investment, you should never invest more than you can afford to lose. This rule equally applies to cryptocurrencies due to their highly volatile nature where traders can experience double-digit losses within hours.
Apart from the fact that crypto assets can quickly lose their value, trading platforms can fall victim to hacks or shut down operations without warning, in which case, investors risk losing all their crypto.
Store Your Crypto in Cold Storage
“Not your keys, not your crypto”. This is the ethos to go by when investing in cryptocurrencies. Storing your tokens on centralized exchanges can be risky, as they can be affected by site crashes, hacks, and even bankruptcy.
Transferring crypto assets to a self-custody wallet can mitigate some of the risks associated with trusting a centralized platform to safeguard your assets. Crypto trading platforms hold your private keys and therefore have control over your tokens.
The advantage cold storage wallets have over other wallets is that they are not connected to the internet. This drastically reduces the chance of hackers and cybercriminals accessing your funds.
Hedge Your Portfolio
Hedging is a tried and trusted strategy heavily used in the traditional financial markets for risk management. It involves buying or selling an asset to potentially help reduce the risk of loss of an existing position or adverse price movements in an asset.
Apart from protecting your cryptocurrencies from violent swings, hedging also limits the potential gains from your crypto investments. A few ways to hedge your crypto are by dollar cost averaging, buying options or futures, and yield farming.
Diversify Your Portfolio
Avoid putting all your eggs in one basket. This statement is true for all investments, including cryptocurrencies. It is advisable to spread your investment across several cryptocurrencies. You can diversify your portfolio based on a project’s use case the its underlying technology. That way, you can better mitigate your risk.
Avoid Excessive Leverage
Margin trading is a very attractive trading strategy in crypto. It is used to increase your order size while allowing you to go long or short. Some crypto trading platforms may offer leverage as high as x100.
While it sounds good, even a 1% move in the opposite direction could wipe out your entire trading portfolio. You could even lose your principal amount if a force liquidation occurs.
A much safer approach would be sticking with lower leverage amounts. This way there is more room to not only increase your gains but you could also have a buffer zone to exit a bad trade.
Approach With Caution
Risk is a major part of any investment experience, be it in traditional or crypto finance, and it cannot be removed entirely. Rather than assuming that all your trading strategies will go ahead as planned, it is wiser and smarter to identify the key areas where risks could emerge and find a way around them.