Over the last 10 years, the price of a single Bitcoin went from zero to $20,000 then down again. In the process, hundreds of crypto millionaires were born - and scores of traders became interested in the burgeoning new asset class.
The good news is, crypto trading can be very profitable. The bad news is, this asset class comes with its own unique risks. If you want to succeed at crypto trading, it’s important to understand these and prepare for them.
To that end, this article will walk you through 6 important risks inherent to crypto and explain how you can deal with them effectively.
All assets are potentially volatile, but crypto coin prices are especially finicky. This was the case in 2011, when Bitcoin lost 94% of its value. It was true in 2014 when Bitcoin lost 63% of its value. It’s still true today after the price of Bitcoin declined 85% since Q4 2017.
There are several reasons for this. The first is that coin prices are almost entirely speculative. In other words, a coin is worth whatever the market says it’s worth; no less, no more. The result is that price fluctuations can be large, unpredictable, and fast.
This isn’t a problem in and of itself. The crypto space’s high volatility gives traders a chance to make outstanding profits. The problem is that there are several risks associated with high volatility.
First, dealing with prices that change constantly can be psychologically difficult. Imagine buying a coin you’re confident in and seeing 5% of its price wiped out in seconds. This is a rare occurrence in, say, stocks; with crypto, it’s common.
Second, high volatility requires being more disciplined and doing a little more work. For example, rapid price fluctuations force you to plan your stop loss levels, entry points and exit points with a lot more precision.
For these reasons and the potential to lose large sums, market volatility is the #1 risk for crypto.
Legal support has been a major obstacle for crypto’s mass adoption in 2018. We have some experience in this department, as our exchange - Adara - is focused on regulation-compliant security tokens among other crypto assets. Here’s what we can tell you so far.
First, crypto tokens have a shaky legal status in many countries. Their use is restricted in China and India, actively punished in Bangladesh, and legally grey in countries like Russia. Other countries like Canada and the USA, where owning crypto tokens is legal, have their own rules. For example, the USA lets people hold coins but restricts their involvement with ICOs.
The good news is that widespread adoption is likely in the future. The bad news is that we don’t know when this will happen, or on what terms. Meanwhile, coins have no solid legal footing which places traders in a precarious position.
On one hand, crypto trading is highly profitable. On the other, governments may ban, tax, or otherwise hamper the space in the future. The odds of this happening are low if you live in Canada, the US, the EU, and other developed countries - but remain a real risk for the rest of the world.
The nature of blockchain technology means that any true blockchain is supralegal. It cannot be controlled by governments, banks, or individuals, as it is fully automated and digital.
This is part of blockchain technology’s initial appeal. Unfortunately, it also means traders have to deal with risk. Governments have no control over the space, which makes it hard to tell which of the 2,000+ altcoins in existence are backed by real projects and which aren’t.
Moreover, virtually all coins are uninsured and uninsurable. The value of any given coin could plummet at any given moment. If this happens, there’s little a trader can do, even if the reason for the devaluation was mismanagement, fraud, etc. The lack of regulations and controls means that illegal market manipulation strategies - pump-and-dump schemes, ramping markets, churning, etc - are easier to execute and more frequent than with, say, stocks.
As a trader, you can’t sell off a crypto coin unilaterally. Any trade needs a buyer and a seller to get filled. This means that a coin pair needs to have volume and liquidity if you’re to buy or sell effectively.
The problem is that a lot of the time, the most profitable coins are tough to sell. For example, you may find that the most profitable trades you can make have Bitcoin on one side and a rare altcoin on the other. The risk in these kinds of situations is that once you buy into an altcoin, you won’t be able to sell it at a profitable price.
Alternatively, you may find that you can sell it profitably by holding on to it for a while. This is not necessarily bad, but it’s more of an investment than a profitable trade and therefore suboptimal.
One possible solution here is to pay careful attention to the volume indicator and other signs that indicate a low demand for a coin. As always with risk management, look before you leap.
Since cryptocurrencies came into existence, over a billion dollars worth of coins have been stolen. This includes multiple instances of cryptocurrency exchanges getting raided and hacked. Fortunately, most modern exchanges have learned from past mistakes and are focused on creating a more secure trading environment.
The problem is that many traders aren’t aware of just how easy it is to lose crypto coins to criminals. A single e-mail link clicked, a single web page opened, a single response to a message from a stranger: this is all it takes to lose some or all of your trading capital.
So make sure you keep your private keys safe. Use 2-factor authentication wherever possible. Protect your physical access points, i.e. make sure nobody can see you keying in your password and login information.
Most importantly, remember that cryptocurrencies are, for the foreseeable future, unregulated. If anything happens to you while you’re trading, you won’t be able to return what you lost. No government, exchange, or bank controls the flow of cryptocurrencies.
Fortunately, cybersecurity risks are decreasing as time goes on. So long as you keep the risks above in mind and follow our step-by-step guide to crypto safekeeping, your funds will be safe.
Now let’s recap by listing the 6 biggest risks in crypto:
If you’d like to learn more about dealing these risks and trading profitably, check out our Adara Academy videos on crypto risk management. Inside, we cover advanced trading tips and step-by-step guides with some of the brightest minds in the world of crypto. See you there.