Golden Rules for Crypto Risk Management
All investment endeavors carry an element of risk, crypto included. Learn how you can manage those risks effectively and make informed decisions.
Nothing can spark a conversation better than the topic of investment options and risk management, particularly when it comes to crypto.
Investment is regarded by some as a methodical approach to managing life savings. Others see it as a social norm, to show that one is capable and responsible for one’s own finances. Still others ‘try to get lucky’ in a randomly-picked cryptocurrency, hoping for quick wins.
No matter how you see it, investment is a highly personal endeavor, because everyone’s risk tolerance is different.
So, before we get into managing risk for crypto investments, let’s learn about some universal truths about investing.
All investments carry risk, some greater than others
If you think about it, there is no such thing as risk-free investments. Investing in property may seem like a risk-free investment since land prices rarely ever crash. It has intrinsic value, too. If you don’t sell it, you can still use it to live.
But a high overhead cost and long-term commitment are risk factors by some people, especially young, modern-day folks who are not ready to settle.
It’s never the market’s fault
Whales (large buyers), market makers, pump-and-dump masterminds, or the crypto influencers make the price swings go wild. While these people are responsible for market behaviors, they are not responsible for your profits or losses.
With crypto, it’s often easy to get caught up in the hype from news and media that can trigger unwarranted coin purchases. For example, Elon Musk is notorious for pumping Dogecoin and Bitcoin on his Twitter, which in turn can exacerbate the hype and cause some people to buy crypto out of fear of missing out (FOMO).
As with any investment endeavor, you are responsible for your decision makings. Your timing, your experience in the market, how much to invest, fundamental indicators, and where to invest – all need to be taken into consideration.
Related: 3 tips to help you avoid crypto FOMO.
No human being are completely rational agents
You may spend years studying economics and human behavior. Your theories may apply to some market phenomena, but in the end, the market would always do ‘stupid things’, like buying when the price moves up, and selling when the price crashes.
Investment is all about temperament, and if you can be more rational than many other market participants, which often requires you to be a contrarian, your investments may end up profitable.
Also read: Beginner Bitcoin investment mistakes to avoid.
Simple rules for effective crypto risk management
Managing your crypto investment risk works the same way as for any other asset class.
In this article, I won’t talk about technical indicators or fundamental analysis. I want to make this as simple as possible so that it sounds like common sense.
Below are a few things to keep in mind and consider to help mitigate your risk when investing in cryptocurrency.
Determine your disposable income
Disposable income is how much money you have left after you subtract your income with all the necessary spendings. Necessary spendings don’t just include weekly groceries and rent or mortgages. This also includes savings for rainy days for the year ahead.
Common sense, I know. But you’d be surprised that many people don’t think this through during periods of market euphoria. In early 2021, I witnessed a few of my friends trying to ‘strike it rich by investing in Bitcoin with all of their net worth.
Now, I hope that what they referred to was their liquid assets. I also read that some people didn’t buy crypto with their assets, but with debt. I wish great success to those people if they had timed the market right.
Knowing your investment budget and being honest with yourself will save you from future pains.
Plan for a diversified portfolio
You may not be interested in investing in shares, government bonds, precious metals, or even managed funds or ETFs. You may feel like investing in these assets pose a great opportunity cost (read: a big waste of potential gains).
But so many people focus too much on the potential gains, but haven’t really considered the potential loss. The price of a company’s share may fall down to as much as its book value. The price of gold may fall down to as much as its lowest price in the previous year.
Cryptocurrencies, depending on which one you’re talking about, can either be priceless or worthless. I found bitcoin to be too strong to become completely worthless, but some crypto assets have been around for less than a year – these are still unproven and are highly risky.
It’s all about balance. Read how you can maximise the risk to reward.
Crypto assets are amazing investment vehicles, and they actually account for about 25% of my investment portfolio currently. Out of this amount, a large portion of it goes to HBAR, with very little going into BTC and ETH.
Although I’ve been quite profitable this year, this is all going to change, because it’s too risky for me personally. Being a moderately risk-averse person, a solid crypto risk management plan was definitely on the table before I jumped into the crypto space.
This does not mean that I will sell my current assets. I believed in what I invested in, and I will diversify my crypto portfolio better as time goes by.
This is aligned with Universal Truth #1, all investments carry risk, some greater than others.
Invest and enjoy the ride
Remember the second and third universal truths? Some newbie investors are either too focused on maximising gains or too afraid of losses. Both kinds of investors just wouldn’t leave the charts alone and get on with their lives.
This is understandable. Many people in the crypto space have never invested in other instruments, not even in company shares. As a result, they come into the ultra-volatile crypto market unprepared.
They may not have gauged the risks of various asset classes, so they held onto the hope that the price chart would always show green numbers and higher prices.
Unfortunately, this is also something that many experienced investors do. It’s almost like Medusa’s curse.
Looking at the price volatility in the crypto market could petrify you on the spot. Then the same familiar feeling of doubt may rush in – Is it the right time to sell?…. How about now?…. now should be perfect, right?
Getting on with your life, and checking the price charts once every few days should be sufficient. If you had correctly gauged your risk tolerance, then your life should not be affected by a price crash — which happens from time to time.
If you have done your research, and firmly believe in your chosen crypto asset, then a bearish market condition shouldn’t be a big problem for you.
Sometimes the best way to manage risk in crypto investment is to refrain from selling at a loss and finding something else to do.
Bear market? No problem. Learn how to approach investing crypto in the bear market.
In summary, crypto risk management is not really that complicated. In fact, it’s arguably common sense, even.
It’s just that people treat cryptocurrencies differently from other investment vehicles – the underlying discipline required to invest successfully is the same as any other assets.
So, familiarise yourself with the three universal truths about investing, and invest with a plan – invest intentionally, and do not give yourself to fear of missing out (FOMO) and fear, uncertainty, and doubt (FUD).
Disclaimer: The information and discussions in this article are to be used purely for educational purposes only. It is not to be interpreted as financial advice, please conduct your own research and due diligence before investing.
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Disclaimer: Information is current as at the date of publication. This is general information only and is not intended to be advice. Crypto is volatile, carries risk and the value can go up and down. Past performance is not an indicator of future returns. Please do your own research.
Last updated February 15, 2022