How to manage risk in crypto investment
Are you interested in investing in cryptocurrencies, but you’re feeling overwhelmed by the risks that come with it? Don’t worry! Managing risk in crypto investment is not as daunting as it may seem. In this blog, we’ll explore the best ways to manage risk when investing in cryptocurrency, so you can feel confident in your decisions and reap the rewards of your investments.
From analysing all kinds of risks, to diversifying your portfolio or understanding the fundamentals of the industry, we’ll cover it all. So, if you’re ready to get started, let’s jump in to learn how to manage risk in crypto investment.
How to manage risk in crypto investment ?
Overview of Risk in Crypto Investment
Risk management in crypto investment is undoubtedly one of the most important factor influencing whether of not you are going to earn money.
Because of that, it is capital that you come up with a strategy in mind before investing. Risk management is a major point in your overall strategy.
However, even though everyone is talking about how risky is Bitcoin and all cryptos, after reading this post you will understand that risk is a subjective topic, and when mastered, it can be lowered to acceptable levels to anyone.
If you read carefully those lines, you will be able to identify all kinds of risks you are exposed to, which will help you learn how to manage risk in crypto investment. Moreover, you will identify your risk tolerance, which determine your financial capacity to invest into cryptos.
Step One: Research the Crypto Market
Learn the Basics of Cryptocurrency
Cryptocurrencies and blockchains are revolutionizing our society and our financial world. If you are new to this topic, it is important for you to understand what stakes are involved. Here is some lecture that will help you understand the overall context :
Understand the added value of crypto projects
There are more than 20 000 cryptos projects referenced on coinmarketcap as today. But what is their purpose ? If you think you already understand cryptos, you must ask yourself, what is the added value of these projects to our society, or financial world ?
What is different between Bitcoin and Ethereum ? By understanding the purpose of a project, you are able do determine whether or not this project has a future. If a project has a real added value, it will be utilized by companies, or by individuals.
The speculation aspect of a project is inevitable, but when this is its only reason for living, it will most likely disappear at some point.
As an example, popular meme coins such as Dogecoin or Shiba inu, all started as a joke and has to this day no real value. They are extremely volatile, and sensitive to news such as Elon Musk tweet or anything related.
This kind of token could go to 0 in a few days if trust is lost. You must be very careful when buying this coin as it is only based on people’s speculation and nothing else.
On the long run, a few projects will survive. If they don’t add value to our world, they will die. If you want to understand why Bitcoin exists, please read this article, also linked above (Why is Bitcoin a revolution).
On the other hand, Blockchains such as Ethereum adds value to the society by implementing smart contracts. If you are not familiar to what a smart contract is, and why it is useful, please read this article :
Differentiate their added value to our society
Moreover, in the process to learn how to manage risk in crypto investment, it is important for you to understand what kind of utility a project have. By understanding their business model, you can identify what they are used for. And because of that, you can determine categories.
Why does this matter ? Because in risk management, you don’t want to “put your eggs in the same basket”. If you identify the most important activity sectors, you will be able to diversify.
In the traditionnal economy, it’s like avoiding buying share only from travel companies. You would have been severly hurt by covid recently. Moreover, if you buy only in the same activity sector, you will most likely buy coins from self competitive projects, and most of them won’t survive from this competition.
Here is some examples of diversification to make it easier to understand.
- Bitcoin : Mother of all coins. Value storage / peer to peer value transfer without intermediaries / inflation resistant on the long run
- Ethereum : Smart contracts blockchain
- Chainlink : Oracle blockchain
If you have never heard of Oracles, please read this article to make it easier for you to understand :
- Cosmos: Layer 0 Blockchain
If the word layer doesn’t mean anything to you, please read this article to have a better understanding :
- Uniswap : Defi platform. ( Defi = DEcentralized FInance )
Uniswap is a cryptocurrency exchange which uses a decentralized network protocol. The protocol facilitates automated transactions between cryptocurrency tokens on the Ethereum blockchain thanks to smart contracts.
Those 5 projects have a different value to our society and could all coexist for the next 10 years. This could be a diversified crypto portfolio to posess.
Analyze the Market
By analyzing the market i don’t mean being constantly looking for opportunity, or watching graphs. I simply mean analyze the big tendencies of it.
One big part of risk management is aiming for medium/long term investment, as it is much easier to generate profit on a long scale. Crypto market is a rising sector and there is / will be huge opportunity for anyone patient enough for the next 10 to 20 years.
In order to have a better understanding of what is happening on the markets, the most important thing to ask yourself is : Are we in a bull market or bear market ?
Let’s make it easy to understand :
- A Bull market is a market growing, with green lights everywhere, recovering from a Bear market
- A Bear market is when all prices crash, and people are running away from cryptos
Now that you understand that, you have to know different things :
- Most people invest their money in Bull market, thus loosing a lot
- Few people who actually make (a lot of!) money in crypto are the one buying in Bear market
As crazy as it sounds, you have to know that the vast majority of people are investing when it’s exploding, loosing money, making a few opportunists people even richer, the ones who invested in bear market.
Don’t be that person. Learn, analyze, understand how it works. First of all, you have to be able to analyze general trends of Bull and Bear markets :
If you want to make money, you need to be swimming against the current. You think it is risky to buy Bitcoin when it reaches its all time low ? You could never be so wrong.
The most risky thing to do is buying an asset when it reached its all time high. Learn to buy low.
Step Two: Establish a Risk Management Plan
Now that you might have a better general understanding of how the market works, you need to organize your work and set up a risk management plan.
Understand Risk Tolerance
This key point is really important and is different to any of us. That’s why anyone willing to invest money in crypto must do it before anything else.
First of all, you need to understand that risk is highly correlated to the amount you invest , in proportion to your total assets / income. The important key here is how much you invest, not what you buy. Let’s take two opposites example to make it easier to understand :
- You buy a 2$ ticket to the national lottery : Even though your winning chances are close to 0%, this is not a risky investment.
- You invest in real estate by selling everything you have + borrow money at high rates : this is considered risky. Even though real estate is often considered a safe investment, your personnal risk into this investment is high.
Risk is all about how much you can afford to loose. It is correlated to how much you possess. Let’s take 1000$. For a person with minimum wage, with no savings, this is huge. For a billionaire like Bill Gates ? He could afford to loose it every day for his whole life without even noticing it.
Key factors influencing risk aversion
To determine your risk aversion, here is a couple of question you need to ask yourself :
- Do you have credits that you must pay back each month
If you already have bank debts, this is your priority to pay back each month. You certainly don’t want to be in a situation where you can’t pay it because you invested too much in cryptos.
- How many people do you have in charge ( parents / children )
This is the kind of expense you can’t avoid. Paying for your children is your top priority and can’t be traded for anything else.
- How strong is your actual job
Do you have a contract in a strong company ? Are you only earning money through bonuses ? Are you a self entrepreneur with low experience and irregular incomes ?
- What are your self financing capabilities
If you loose your job tomorrow, how long can you survive with passive income / patrimony ? Estimate this in months according to your actual expenses.
- How fast can you find another job if you loose your actual job
Your actual job is your main income revenue. Imagine that you loose your job. What are your capacities to bounce back and work again soon ? Try to estimate this as objectively as you can.
- Do you have a plan B if you cannot pay your rent anymore
Are you a student that live on your own but could come back to your parents if situation requires so ? Or a married husband with two kids with no close relative around ?
- How much pressure can you personnaly handle
Some people are just not comfortable with taking risks. Take a second to imagine holding cryptos that could loose 20 % of their value in one night. Is that a situation too stressful for you ? Ask yourself if you are the kind of person who likes to play, try things, or always be secure.
If you are not a risk taker, i would not recommand going into crypto field.
Concrete example of risk aversion analysis
Those questions must be answered very precisely and objectively in order to determine your risk aversion. Let’s compare two example in order to understand the stakes here :
- Example 1 : You are a young student going to college, living at your parents house. You have a part time job. No credits, no chilren in charge, your job is doing well, manager is happy about your work. Low daily expenses, you don’t pay rent. Your parents own their house, and are about to retire from a full working carrier.
Even though you only earn for example 500$ a month for your part time job, you could easily invest 20 to 50 % of it each month, with low risk (depending on various additional factors). You could afford to loose it with no negative consequences to your actual life. In this example, investing 150$ a month is not risky.
- Example 2 : You are a happy father of one kid, and your wife is pregnant for a second one. Your just bought a house, and pay a credit for it. You both work, but the financial status of your company in unsure. Let’s say you personnally make 2 500 $ a month. You also have a car and a credit for it. You don’t have much savings because you invested a lot in your house. Your parents could not really help you, they live far from where you live and they have a small pension.
In that situation, investing more than 5 % of your income in cryptos seems like a risky business. 5 % of 2 500 $ is only 125 $.
As we can see, comparing these two examples : Example 1 is earning way less money each month, but has very low charges / credits. Example 2 theoretically earns more each month, but has way more expenses he can’t avoid.
If these two people would have done their own risk aversion analysis properly, I would personnaly consider that the example 1 (student) could afford more in raw investment than the second example.
Now take some time to do your own analysis through all of these questions.
Set Investment Goals
Now that you have a better understanding of your personnal risk tolerance, you can start to set up your investment goals.
When you are about to invest in cryptocurrencies, you need to ask yourself :
- What is my objective in terms of gains ?
This question must be asked and need to be analyzed in order to be realist. It has to be coherent regarding your initial investment.
Let’s say you invest 100 $ and wants to be millionaire. This is clearly not possible, or you would have to expose yourself to sugh a high risk that your chances of winning are like national lottery : close to 0.
You have to determine your objective in terms of multiplying factor of your initial investment. They need to be coherent regarding the kind of assest you are aiming to invest in : All projects have a different potential in terms of increase in %.
To make it simple :
- The closest you are to #1 Bitcoin, the safer you are, the lowest your multiplying factor will be.
If you invest in a bear market on Bitcoin, you could do a x3, x5, or x10 on longer period, but it will be harder to go higher. Let’s say you bought Bitcoin in end 2022 at 17 000 $, to make a x10 Bitcoin must reach an all time high of 170 000 $. This is uncertain. Its last top high was almost 70 000 $, so it’s more than the double of its all time high.
- The more you go down in market cap projects, the higher the profits could be. However, remember that high hypotetical profits always means higher risks.
Let’s say you invest in a top 50 crypto : Elrond (MultiversX). End of 2022, its price is about 50$. Its all time high about 2 years ago was 500$. You could have a x10 if it reaches this again. On the next Bull run, it could go higher. You could have a x15 or x20 on this kind of asset. Remember, the higher the return, the higher the risk !!
A diversified portfolio is key here. That’s the next part of this tutorial.
Diversify Your Crypto Portfolio
As i previously explained, you have to diversify your portfolio. Diversification has different advantages :
- You spread risk among various assets
By the end of 2022, the FTX platform collapsed, even though it was one of the biggest actor of the crypto market. There is no doubt that some people lost a lot of money in it. Some of them who had 100% of their token in FTX. They lost everything they had.
- You diversify your potential gain / risk
As i said earlier, your potential gain is variable, according to the risk. Most of your tokens should be on cryptos close to top 20, but you can take higher risks on a smaller portion of your portfolio, by going under top 50 / 80.
- You avoid too much self competition on your assets
If you invest only in Layer 1 Blockchains for example, such as Ethereum, Solana, Elrond, Algorand, or Cardano, there is a risk that competition will kill most of this projects, thus killing your portofolio with it.
On the long run, only a few in each domain will survive. Compare it to search engines tools such as Google and Bing. In the early 2000’s, there was so much more competitors. In 2022, more than 82% of the market share is owned by Google only. Most of the competition didn’t survive.
The same thing will happens in crypto. Competition will make survive the strongest projects and make the others disapear.
Don’t try to find the next Bitcoin
What i mean by that is, don’t look for an opportunity on the deep of the crypto ocean. Everyday, you hear about a project whose price rose to 1000%.
Deep down into the low market cap projects, outside of top 1000, some projects can make some astounishing rise. Here is an example :
Why you should never try to find those coins :
- If you heard about this when it went up, it’s already too late.
- The market cap is so low, that even if you bought it before it goes up, there is a high chance that no one would even buy it from you. Remember : this is a market place with seller & buyer. If you want to make profits, you need to find a buyer.
- There are so many scams. Because anyone could create a token, and the regulation is still late, a lot of people are using this to scam people. The exceptionnal numbers we sometimes see make everyone believe they can earn a lot of money easily. This is an illusion.
- The survivorship biais : You may have heard about crypto project whose price rose to 1000%. But how many project went from a certain price to 0 ? Everyday there are hundred of those you never heard of. The storytelling is mainly influenced by projects who rise, not those who fall.
Crypto risk management : secure your funds
There are several steps you can take to help secure your cryptocurrency funds:
- Use a hardware wallet: A hardware wallet is a physical device that stores your private keys offline, providing an extra layer of security against online threats. Hardware wallets are generally considered to be the most secure options for storing cryptocurrency :
Make sure to read this article in order to better understand the stakes involved :
In addition to use a hardware wallet, here is some other recommendations to keep your funds safe :
- Enable two-factor authentication (2FA): Two-factor authentication requires you to provide an additional piece of information (such as a code sent to your phone or email) in order to access your cryptocurrency wallet or account. This helps to prevent unauthorized access to your funds.
- Use strong and unique passwords: Make sure to use strong, unique passwords for all of your cryptocurrency accounts and wallets. Avoid using the same password for multiple accounts and consider using a password manager to help you generate and store strong passwords.
- Keep your software and devices up to date: Make sure to keep your software and devices up to date with the latest security patches and updates. This can help to protect against vulnerabilities that could be exploited by hackers.
- Be cautious when sharing personal information online: Be careful about sharing personal information online, particularly in the context of cryptocurrency. This includes things like your name, address, phone number, and other identifying information.
By following these steps, you can help to protect your cryptocurrency funds from potential threats such as hackers and cybercriminals.
Overall strategies to minimize risks in crypto investments
Here is some more advices in order to minimize risks in crypto investments.
Long term strategies are more efficient in investment
- Market volatility : Cryptocurrency prices can be highly volatile, and short-term investments may be more exposed to this volatility. Long-term investments, on the other hand, may be less affected by short-term price fluctuations, as they have a longer time horizon to potentially ride out any market ups and downs. Because cryptocurrencies are a rising market, the overall trend is upward.
- Risk of losses : Short-term investments carry a higher risk of loss due to their shorter time horizon. If the market moves against you or if an unexpected event occurs, you may not have enough time to recover your losses before you need to sell your investments. Long-term investments, on the other hand, have a longer time horizon to potentially recover from any losses.
- Diversification : Long-term investors may have the opportunity to diversify their portfolio more effectively, as they have more time to add new investments and potentially spread their risk across a wider range of assets. This can help to reduce the overall risk of the portfolio.
- Compounding returns : Long-term investments may benefit from the power of compound returns, where the returns on an investment are reinvested and earn additional returns over time. This can help to increase the overall return on the investment and potentially reduce the risk of losing money. As an example, you can directly stake your coins through Ledger wallet :
- Trading fees : On most trading platforms such as Binance, you pay fees anytime you buy or sell your coins. The fees are around 0.1 % of your total ownings. If you do transactions once every 2 or 3 years, you pay almost nothing. However, if you trade every day, you will have to pay those fees each time a transaction is done, drastically reducing your potential gain.
Crypto investment : Stay Up to Date
Staying up to date on crypto markets is important for a number of reasons.
- First and foremost, the cryptocurrency market is highly volatile because it is an emerging market. Everything is evolving really fast so it’s important to keep your knowledge updated. By staying informed about the latest developments in the market, you can make informed decisions about when to buy and sell your digital assets, potentially maximizing your returns.
- Additionally, staying up to date on crypto markets can help you stay abreast of new developments in the world of cryptocurrency, such as the introduction of new coins or the adoption of blockchain technology by major institutions. This knowledge can help you make informed decisions about your portfolio and investments.
- Finally, staying up to date on crypto markets can help you stay safe from scams and fraud, as you’ll be more informed about the risks and potential pitfalls in the market. As an example, people who had money on the platform FTX which crashed in 2022, whoever was fast enough to react could potentially withdraw their assets from the platform before it was too late.
Re-evaluate Your Risk Management Plan Periodically
It is important for you to periodically re-evaluate your risk management plan because the potential risks you might face can change over time. This can be due to internal factors such as changes in your personal circumstances or goals, or external factors such as changes in the environment or society.
By regularly reviewing and updating your risk management plan, you can make sure that it remains effective and relevant in addressing the current and future risks you may face. This can help to minimize the impact of any negative events on your life, and ensure that you are well-prepared to respond to and manage any risks that do arise.
Additionally, periodic review of the risk management plan can help you to identify any gaps or weaknesses in the current approach, and allow you to make any necessary adjustments to ensure that you are as protected as possible.
Conclusion on risk management in crypto
In conclusion, managing risk in crypto investment requires a multi-faceted approach that involves understanding the different risks associated with what i mentionned in this article :
- Research the Crypto Market
- Establish a strict risk management plan
- Secure your funds
By taking the time to carefully assess and mitigate the risks involved in crypto investment, you can minimize the chances of significant losses and increase the likelihood of successful returns.
This requires a combination of careful research, regular review of your portfolio, and an understanding of the various tools and strategies available for managing risk.
Ultimately, managing risk in crypto investment is a continuous process that requires ongoing vigilance and a willingness to adapt to changing market conditions.
By staying informed and proactive in your approach to risk management, you can increase the chances of success in your crypto investment endeavors.