Risk Management for Token Investments

Why do you need Cryptocurrency Risk Management? One day the value of your portfolio is up 10%, the next day it may be down 20%. Cryptocurrencies are extremely volatile, highlighted by recent events. All the more, it is important to have an effective risk management for your token investments to make sure you don’t loose your hard earned money. Following a handful of steps can go a long way and help that things don’t end in tears.

Even when James Dimon, the CEO of Wall Street giant JP Morgan, said that he would fire in a second any of his traders who were trading Bitcoin, we knew that trading in cryptocurrencies wasn’t bad business. On the contrary, some ICOs have returned more 3000% on investment and even if you had bet on “mainstream” coins like Bitcoin and Ethereum you could have made a nice profit in the last year. Now you may have noticed that there has been a bit of a sell off but the above is still true despite the recent dive cryptocurrencies took. As of today, Bitcoin is still worth seven times what is was at the same day last year, while the value of Ethereum has multiplied by 65, to remain with the same examples. Not to mention the profits you could have made if you would buy and sell at the right time in a highly volatile market. This correction or whatever you may call it highlights though that risk management is an essential piece of any trading strategy.

The first rule

The first rule cryptocurrency trading and risk management is that if you invest in cryptocurrencies, you shouldn’t invest anything that you cannot afford to loose. While this is generally pretty good advice for any kind of risky investments, it is particularly true for cryptocurrencies: no one knows for sure where this is heading, but if you decide to invest in ICOs that are based on little more than an idea, there is a high probability that the venture behind the fundraising may fail and investors left empty-handed.

There are a couple of steps you can take and factors you need to understand to reduce the risk. By how much eventually depends on every individual and the investment decisions.

Know the basics

Underlining the importance of the first rule is the technology factor of cryptocurrency investments. This is still early days comparatively and a look of things can go horribly wrong because the technology is at an early stage. On one hand, you have the technology of the various intermediaries between you and your tokens, e.g. the exchanges, the wallet providers etc. They can loose your tokens because they get hacked (see Coincheck), go bankrupt (e.g. YouBit) or simply screw things up in another way (e.g. Coinbase). It’s not said that they do and the risk is also there in more traditional areas of finance, but as many of these firms are start-ups the risk is proportionally higher. On the other hand, there is the technology risk at your own end, i.e. storing tokens where you don’t loose them. Look at rapper 50 Cent who forgot he had Bitcoins and while 8 million makes for great headlines, there are plenty of others out there who lost their passwords, computers or storage devices that will keep them from their investments eternally. So, the advice is make sure things are as safe as possible on your end and have an eye on whoever you deal with. If there have been news about that particular currency exchange having trouble for weeks, it might not be the best idea to leave large amounts of tokens there – not that leaving them in a hot wallet for a long time would be a good idea in general.

The Financial Risk

We don’t want to bore you with the first rule, but there is a real chance that you might lose your entire investment. From its all time high right before Christmas to its current value Bitcoin has lost almost two-thirds in about six weeks. It’s not said that it won’t be up there again and in fact, there are still plenty of people predicting a meteoric rise to new heights, but if you needed that money back urgently, you would find yourself in a bit of a pickle now, right? Not to mention all those tokens that already have disappeared and with them the investments of their investors that won’t see any of it back. There are a couple of ways to put safeguards in place from setting price alerts through a service like Coindera, placing limit orders, or hedging through options, but especially with regard to latter make sure you stay on top of the numbers as leveraging goes both ways.

Start-Up Investing on Steroids

We already mentioned the bankruptcy risk above on the example of the YouBit exchange, but the same is true for all forms of blockchain and cryptocurrency start-ups. One of the reasons, people are using ICOs to raise funds is that it is a way that is less scrutinised than other form of fundraising. It’s not necessarily said that they all go bust and that other start-up investments are less risky, but if firms simply have nothing but an idea, the chances are that things could go awfully wrong and end in the company shutting the doors forever. So, to reduce the particular aspect of company failure, make sure you’ve done your homework before you invested in a token only because of a fancy name or you like the logo.

The Legal/Regulatory Risk

The whole Cryptocurrency sector isn’t an unregulated space and never was as some tried to make you believe or wanted to believe themselves. Instead there are plenty of rules that are applicable and regulation is one of the hottest topics right now. At the same time, there is still relatively little protection for investors and there is certainly no form of deposit insurance like you might know it from your regular bank account. But regulators around the globe are tightening the screw, from enforcement actions to halt individual ICOs to banning certain activities to people ending up in jail eventually, there is the whole nine yards. We certainly are going to see more regulatory action in the coming months. However, if something goes wrong at one of those companies, it doesn’t mean that you might get your money back. Therefore, try to understand the framework you and the firms you invest in are operating in. While many have not been touched by the regulator’s long arm or believe they may have found a way around the legal obstacles, it doesn’t mean it will not end in tears eventually, so factor these considerations in your decisions in, too.

The Psychological Trap

Investing in cryptocurrencies is nothing for the faint hearted. One day a coin is up ten percent, the next day it may be down twenty and the last weeks have been particularly testing for those that believed that the rise in crypto prices might go for many years to come. Sure, it’s not said that things aren’t going to turn around soon and making predictions about the movement of cryptocurrencies is the least we want to do in this article. Unless, you’re actively trading on a daily basis and trying to make money by exploiting the wild swings in value, checking the prices might do you more harm than good. If you let yourself drive by emotion rather than facts, there is a high probability that you won’t be able to realize the potential of your investment. If everyone buys/sells it might be a good time to buy, too, but make sure you don’t follow the herd blindly to the slaughterhouse.

Lavanya Rathnam

Lavanya Rathnam is an experienced technology, finance, and compliance writer. She combines her keen understanding of regulatory frameworks and industry best practices with exemplary writing skills to communicate complex concepts of Governance, Risk, and Compliance (GRC) in clear and accessible language. Lavanya specializes in creating informative and engaging content that educates and empowers readers to make informed decisions. She also works with different companies in the Web 3.0, blockchain, fintech, and EV industries to assess their products’ compliance with evolving regulations and standards.

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