Cryptocurrencies are an emerging asset class that is difficult to comprehend and evaluate. Therefore, it is essential that investors use crypto risk management with an objective, informed perspective.
Risk Management Challenges
To begin, each cryptocurrency has its own unique characteristics and cannot be substituted for another. Risk managers are faced with a challenging evaluation task as a result of the extensive feature set, which includes characteristics such as programmability, security, and governance. In addition, there aren’t any methods of valuation that have reached a consensus, and there isn’t much information reported about prices, so it might be difficult to assign a reasonable value to cryptocurrency coins.
The volatility of cryptocurrency markets presents a particular and distinct set of challenges for risk management. It is possible for individual digital assets to experience extreme highs and lows within the span of a single day, with no discernible pattern to follow. Volatility can be a benefit for long-term investors, but it also presents risks if you’re not adequately prepared. It is highly recommended to diversify your investments, especially if you have a substantial amount invested in one coin.
The absence of regulation in the cryptocurrency markets is yet another challenge that must be overcome. This poses a range of hazards, from consumer protection to market manipulation.
Trading & Investment Practices to Manage Risks
When investing in a crypto asset, it’s essential to use a secure wallet and trading platform. Without precaution, hackers could break into your crypto wallet and take all of the funds stored therein. Furthermore, keep your wallet private by not sharing it with anyone else.
Second, cryptocurrency exchanges often differ and have distinct pricing and execution practices. This can have a substantial effect on how risk managers manage their portfolios.
Third, exchange fees can significantly increase the cost of investing in a particular crypto asset or currency. Therefore, it’s essential to know the exchange fees before committing to any transaction.
Fourth, crypto prices can shift drastically overnight, making it tempting for traders to enter or exit positions at the wrong time. Doing so could result in a negative return or even lead to the complete loss of all your money invested.
Fifth, there is an increased risk of losing all your cryptocurrency investment if you lack knowledge about the market and fail to adhere to proper risk management protocols. This is particularly true if you are trading futures contracts using leverage frequently.
When managing risk in the crypto space, it’s best to limit your exposure to just a few coins and trade at maximum risks of 1%-2%. Doing this will shield your portfolio from market fluctuations and ensure you remain out of trouble should something go awry. Furthermore, use a stop loss when making trades and always take profits as soon as possible after each win.
Major Takeaways to Manage Crypto Risks
- If you are investing in the cryptocurrency market, you should trade responsibly which means you must have complete control over your trading strategy and your trades. Responsible trading can protect you against market volatility.
- You should have effective risk management strategies to protect yourself from market manipulations and over-trading. You can use a take-profit or stop-loss order tool to execute your risk management strategies effectively.
There are various factors that create challenges for crypto risk managers. This is why risk managers should understand those factors. Apart from that, a trader or an investor also needs to trade responsibly to manage risks in crypto trading.