Introduction
Cryptocurrency trading is a skill that needs to be learned and improved by gaining experience. Anyone is not bound to have success in trading cryptocurrencies without spending their time researching these projects.
People put value in stocks because of the performance of the companies that issues them. In the same manner, people trade forex and commodities on account of goodwill in the international markets.
Cryptocurrencies that have both goodwill and real utility can prove to be good trading options, granted that the investors learn to manage related risks.
What is Cryptocurrency Trading Risk?
It is important to note that the first ever cryptocurrency, namely Bitcoin, was introduced as a decentralized network and alternative to paper money. At present, the economic situation of the world has made it clear that systems like capitalism, socialism, or communism are inherently flawed.
At the same time, various types of governments, such as democratic systems, also do not offer the maximum output for the benefit of the masses. On the other hand, financial networks and regulated financial institutions have also failed the masses in various ways.
The world is still dealing with massive governance problems like wars, inflation, recession, economic depression, and unjustified distribution of wealth. Under these circumstances, most economical and political setups are designed to make the rich richer and keep the poor subjugated.
One answer to these issues is in the form of decentralized and autonomous networks such as Bitcoin. Naturally, Bitcoin is just a blueprint to address these issues rather than providing a complete solution.
Bitcoin has given rise to the entire $3 trillion cryptocurrency market, where investors can sell and purchase tokens to make profits. The underlying purpose of cryptocurrencies is more important than just financial system evolution.
Considering these factors, many people claim that decentralized networks can help humanity build a new global economic and political infrastructure. Therefore, there are many staunch proponents of cryptocurrency trading.
However, the cryptocurrency and DeFi sector has a lot of work to do before it can adjust and make some important contributions. The DeFi network can be seen as a rival to the centralized banking and financial infrastructure that ensures financial inclusion and invite people to ask more questions.
Therefore, the cryptocurrency market has gained considerable traction in the marketplace. Considering all these factors, it is quite obvious that cryptocurrencies are going to be around for a while. At the same time, it shows that cryptocurrency trading is going to remain a predominantly risky option.
Use Cases of Cryptocurrencies
The first question that every person should ask immediately is whether cryptocurrencies are a bubble.
The history of financial booms has shown that humanity has fallen for some of the biggest financial bubbles in the past, such as the Dutch Tulip mania and the dot com bubble of the 90s. Based on the historical evidence, many people can assume that cryptocurrencies might be based on speculation and overhyped markets.
Therefore, it is important to examine the inherent utility of cryptocurrencies to find out if they are useful or just marketing shams. Here are some important utilities of cryptocurrencies that cryptocurrency investors tout:
Trading
Cryptocurrencies have become a very popular mode of trading around the world. Since blockchains aim to be permissioned, decentralized, and trustless networks, they are open to international participation.
People like to purchase these cryptocurrencies and hold them for a long duration to make profits. Since cryptocurrencies trade globally, it is natural that they have greater volatility in comparison to stocks.
The investors analyze factors like Market cap, trading volume, market sentiment, real-life integration, and regulatory updates to track the prices and make tradeoffs to increase their profits.
Store of Value
Cryptocurrencies are often seen as a store of value by investors. Imagine a person who is invested in stocks or forex markets. However, they are bound to keep losing money on account of continuous inflation and money devaluation.
It is important to note that economists claim that a consistent increase in inflation is a prerequisite for a healthy economy. Therefore, the people who hold long-term investment positions are bound to burn out a considerable percentage of their profits on account in lieu of inflation adjustment.
Since cryptocurrencies persist outside of the purview of the centralized economy, they are seen as a better store of value in comparison to fiat and other traditional investment methods.
Medium of Exchange
Cryptocurrencies are, at the core, introduced as a substitute for paper currency. The government of each country holds a lot of power in their region on account of its unquestioning hold on the financial networks.
The political elite of one government can make decisions to manipulate and control its masses based on its strong hold on the financial systems. In most cases, the interests of the elite do not align with the interest of the governed.
However, when there are alternative systems such as DeFi and blockchains, the people can claim their power and independence back and enjoy greater financial freedom. Therefore, cryptocurrencies are often seen as a medium of exchange and an alternative to fiat currencies.
Fiat Substitute
Another way that people can take advantage of cryptocurrencies is by using them to make purchases online. The typical fiat currency reserve under the possession of a person is guaranteed to keep devaluating even in the top economies of the world.
However, the typical cryptocurrency is deflationary, and it is bound to keep increasing in value under the hold of the masses.
Therefore, people can enjoy using cryptocurrencies as a mode of payment more than the purchasing utility they get out of paper currencies.
Different Kinds of Cryptocurrency Trading Risks
Cryptocurrencies have been invented to address the important issues plaguing human societies. However, just like any other new technology, they are also in the earliest phase of development.
Therefore, cryptocurrency investors must keep an open mind and remain alert about the trading risks that accompany them. Here are some of the most talked about and debated cryptocurrency trading risks:
Price Volatility
The price volatility of the cryptocurrency market is one of the biggest criticisms that professional investors present. It is important to note that with traditional trading instruments such as stocks and commodities, many institutional investors have stakes in the market.
It means that it is easier for analysts to measure the market sentiment and predict where the market will move. However, cryptocurrencies are directed toward greater financial participation.
Therefore, more retail investors are hailing from all parts of the world. Under these circumstances, the markets are dictated by organic forces, and they are naturally more volatile. Therefore, cryptocurrency investors should always be careful about sharp changes in prices.
Lack of Diversification
Lack of diversification is a personal error that can ruin the investment portfolio for an investor. If an investor is not very experienced and they end up investing only in a single cryptocurrency, their odds of making profits are going to decrease.
Some investors use techniques like hedging to add opposing cryptocurrency options to their portfolios. In this manner, when one cryptocurrency goes up, the other one can start to climb up.
On the other hand, investors can also take a look at the investment options that involve derivatives and other trading options to ensure that they lessen their risk of losing money as much as possible.
Hacks and Exploits
Cryptocurrencies and blockchains are purely digital entities. They use encryption technology that makes it very difficult for anyone to hack them. However, there are still risks associated with hacking, such as a 51% attack where a mining pool with 51% hash rate power can hijack the Bitcoin network and issue double Bitcoins.
Meanwhile, cryptocurrency options like Ethereum have also been hacked and resulted in a fork. Some hackers are looking for technical blind spots on DEX platforms to launch exploits and steal cryptocurrencies from investors.
Private Keys
Cryptocurrency users need to make sure that they keep their private keys and seed phrases safe. The thieves who are after the funds can gain access to the private accounts of the people if they end up getting hold of their private keys somehow.
Therefore, it is of paramount importance that cryptocurrency investors store their private keys in a remote and secure location; otherwise, they also run the risk of getting locked out of their digital wallets.
Lack of Utility
Lack of utility is a big problem that has become visible in the form of meme currencies and shit coins. Taking advantage of the nascent technology, many scammers issue joke cryptocurrencies and hype up the prices in the markets.
These threat actors have already purchased massive amounts of these cryptocurrencies at the very beginning. Once they have pumped the coins through speculation, they sell their massive share and dump the prices.
Therefore, investors must pay attention to the real utility of a cryptocurrency before investing in it.
Security Risk
Blockchain technology has many other use cases for institutional purposes, such as supply chain management. However, many companies refrain from joining public blockchains to keep their information private.
Therefore, in essence, it is not wrong to say that cryptocurrencies are subject to the threat of hacking at every stage, such as buying, selling, storing, and transferring.
Therefore, investors can keep their crypto reserves safe by ensuring that the blockchain has completed the technical audit and combed out all the security threats and blind spots before hackers exploit them.
ICOs
The ICOs or Initial Coin Offerings are events that are modeled on TradeFi practices like IPOs. During IPOs, important startups can amass financial backing from venture capital firms that can get the front seat in an up-and-coming big tech project.
However, with ICOs and IDOs (Initial DEX offerings) retail investors can get the chance to be at the forefront of innovation. It is important to note that big venture capital firms have a huge risk appetite, and they have the resources to conduct important research on their investment options.
However, retail investors can get exhausted sooner with ICOs on account of their smaller capital reserves and their lack of understanding.
Therefore, the investors who are planning to participate in an ICO should conduct in-depth research and perform their due diligence concerning the project founders and reviews.
Liquidity
If the fall of the FTX and Luna projects has taught anything to cryptocurrency investors is that liquidity is quintessential for the survival of a project.
Naturally, most banks and DeFi projects that have huge financial reserves available at their disposal in the form of customer deposits tend to invest or utilize them.
However, all financial enterprises must maintain the amount of liquidity that is sufficient to deal with any urgent financial crisis or as emergency backup funds.
Using Proof of Reserve, DeFi investors can ensure that the cryptocurrency enterprises that have their reserves have sufficient liquidity at all times.
Transparency
There are two sides to transparency while using blockchain or other distributed ledger technologies. The first one is the right of the users to maintain privacy. The blockchains that are unregulated allow investors to create accounts under assumed names and keep trading from remote locations.
In this manner, the identity of the user can remain hidden, and their financial records would not be revealed to the public.
The second aspect of privacy on blockchains is that anyone present on a public blockchain can access all the financial records at any given time. This is important to ensure transparency and make the network trust free.
However, if a person conducts foul play, they cannot be intercepted by law enforcement. But the chances of conducting foul play on a blockchain are not as easy as it is on a normal transaction network.
Therefore, investors should ensure that they gain all the information about the privacy policy and transparency rules of a cryptocurrency before investing in it.
Financial Scams
Financial scams are very common when it comes to any new technology. The historical evidence dictates that human beings have shown resistance towards the introduction of any new technology, even the printing press and books.
Scammers are intelligent criminals who take advantage of the lack of information people have regarding new technology. They distort information and trap their victims into losing money or cryptocurrencies through psychological tactics.
Therefore, investors should make sure that they have done their research on the matter before diving into any cryptocurrency.
Illegal Activities
There are always tiers of criminal conduct in society. Hacks, exploits, and scams can be seen as blue-collar crimes. There is a whole new breed of white-collar criminals who exploit blockchains for their illegal designs. People with massive wealth and tons of assets are always looking for ways to circumvent tax deductions.
Therefore, they can use certain blockchains and crypto-related services to commit crimes like money laundering or illegal funding.
Investors should always keep an eye out for the regulatory reaction towards such issues and make sure that they take out their funds in case there is a probability of regulatory exodus in their region.
Important Crypto Risk Management Strategies
All trading markets, such as stock, bonds, derivatives, forex, commodities, and real estate, comes with various degrees of trading risk.
The investors who are going to invest their time in making informed trading decisions are going to win, while those who depend on luck have a greater chance of losing.
Here are some important risk mitigation techniques that every cryptocurrency investor should know about:
- Investors should always pay great attention to the legal and political development of the cryptocurrency markets. A while ago, the European Central Bank called for imposing a ban on cryptocurrencies; however, it was later dismissed.
- Investors should never put their money into a sector that they don’t understand. It would be impossible for a person to make money from a tech stock or a cryptocurrency if they are unable to read the fundamentals and make sound tradeoff decisions.
- Cryptocurrency investors should always follow the advice that “Not your keys, not your reserves.” Maintaining ownership and control over your cryptocurrency reserves is massively important for investors.
- Cryptocurrency investors should always demand Proof of Reserve disclosure from their crypto services providers, such as custodial services, exchanges, and other DEX entities.
- Cryptocurrency investors must always keep a sharp eye on the available liquidity that is enough for contingency situations at all times.
- Investors should beware of the leverage trading positions, and they must fully understand the requirement for maintaining collateral and the terms of margin calls.
- Investors should use multiple time frames to make sure that they can get the best technical analysis results for trading decisions.
- The investors must make an active effort to manage the trading volume or position sizing that can make or break their net profits.
- Investors should learn how to use stop loss and limit orders to gain full control of their trading ventures.
- Investors can also take advantage of techniques like shorting to keep making money during long bear runs.
- Investors can increase their trading efficiency by investing time in learning about technical indicators such as support/ resistance, moving averages, and candlestick charts to read the market signals more effectively.
Conclusion
There is a considerable amount of trading risks involved in cryptocurrency trading. However, it is important to keep in mind that while the 2008 financial crisis was a result of the housing bubble, it did not mean that the entire real estate market was a scam.
In the same manner, despite the dot com bubble of the 90s, the whole internet economy and internet services were not bogus. Therefore, investors must approach DeFi with an objective mind and hone their deductive skills enough to distinguish the gold from the sham.
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