Cryptocurrencies are notorious for their volatility and can be risky for investors regardless of their experience levels. Most digital assets are susceptible to external factors like market sentiments that can quickly cause investors to lose most or all of their funds. Due to the instability, anyone trading crypto, especially those holding digital assets for the long term, should consider applying one or more risk management strategies to minimize losses.
Although cryptocurrencies may vary by structure and composition, there are general risk management methods holders can apply across multiple digital assets. The following are some of the most effective:
Diversification
One of the biggest risks traders face is the market’s instability. Since price swings can be abrupt and steep, traders must consider diversifying their crypto holdings to reduce the risk of a loss. Instead of keeping all funds in one asset, users should consider spreading their funds across multiple cryptocurrencies to accommodate these price swings. In most cases, established assets like Bitcoin and Ethereum may offer investors more stability than others. However, users can also find a carefully selected new cryptocurrency to spread the risk between established and relatively nascent options.
One popular way to diversify is to consider stablecoins, whose values are pegged to specific assets. Under normal circumstances, stablecoins uphold their peg and maintain the value tied to the underlying asset. However, investors should note that a stablecoin can lose its peg and crash. Also, because stablecoins are not designed to fluctuate, investors may not earn any returns.
Stop Loss Orders
A stop loss order is a feature on most exchange and trading platforms that enables the automatic sale of an asset when the price hits a set point. A similar feature is a trailing stop loss that automatically increases the price point to suspend the order as prices rise and returns increase. While these features may not totally prevent investors from losing funds, they help to mitigate potential losses and avert complete bankruptcy.
Safe Storage
Safe storage is one of the most critical parts of crypto investment and usage. Many people, regardless of the size of their portfolios, are fine with storing their assets on a centralized exchange because it is easier to access. However, centralized exchanges are more susceptible to security breaches because nearly anyone that can break the platform’s security measures can access or steal saved funds. According to a Chainalysis report, $3.8 billion was stolen from crypto businesses in 2022 alone.
Active traders may leave some crypto on a centralized exchange to make quick trades. However, users should consider keeping most funds in hardware wallets where no one can remotely access or steal funds.
Minimal Investment Deposits
Although the amount invested directly informs potential profit, a general rule of thumb is to only invest amounts that are easy to lose. Depending on the asset and market conditions, users can quickly turn their investments into fortunes. However, the risk of losing funds and experiencing double-digit plunges in the crypto market is ever present.
There is also a problem with government regulation. In most regions, legislation guiding the crypto sector is inadequate or unclear. Government agencies like the United States Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC) are very harsh on the crypto sector, and have been repeatedly criticized for using enforcement action on the industry. For instance, in a June indictment accusing Binance of malpractice, the SEC designated several tokens, including MATIC and SOL, as securities. Following the announcement, several of these tokens lost 6% to 20% of their value in response. The continuously changing regulatory environment is another reason users are largely advised to invest only amounts they can lose.
Do Your Own Research
Every user must do their own research on crypto projects before committing funds. The research process should involve a thorough examination of the project, including its whitepaper, software architecture, and business model. Users should also scrutinize the team of developers behind the project to ensure that none have a history of involvement with rug pulls or other scams. In addition, the research should indicate checks and balances the project has put in place to uphold security standards, comply with regulation, and maintain decentralization.
