Crypto risk management
As with any asset class, there are risks associated with crypto investing. Historically, one of the biggest risks has been around custody. “In the early days, you saw a number of exchanges suffer from hacks or theft of funds without appropriate insurance or custody procedures in place, leaving investors without any compensation or recovery of those assets when something went wrong,” says Mosoff.
Investors who move assets offline to cold wallets must contend with managing the private keys—complex alphanumeric passwords needed to access their assets.
The recent crackdown on cryptocurrency mining and trading in China and the outright ban of crypto assets in several countries, show that regulations could be a significant source of risk.
Crypto investing also carries transaction risks—for example, mistakenly selling the wrong crypto, or sending crypto to the wrong person—that could lead to irreversible losses, says Cheah.
Other crypto risks include security breaches and the sudden shutdown of trading platforms. There have also been instances when millions of dollars were lost “due to programming risk such as bugs in some cryptos leading to liquidity being drained out from some smart contracts,” says Cheah.
As with any new technology, kinks will have to be ironed out over time, but some risks may have to be managed and mitigated with due diligence and common-sense practices.
The best hedges against volatility, for instance, are diversification and investing in safer assets. The risk of cybercrime can be mitigated by ensuring the brokerage or exchange has safeguards in place and has secured regulatory approval.
Investor education is the best tool for risk mitigation, Shafrir says. It’s essential to know how to safely buy, store and transfer crypto.
Bitcoin bias and choices beyond
Bitcoin bias is an undeniable reality. There’s even a term for the dyed-in-the-wool bitcoin bulls, who tend to believe all other digital coins are doomed to fail—Bitcoin Maximalists.
“That is extremely short-sighted and misguided, because if you look at the amount of developer activity and usage happening on networks like ethereum, it’s foolish to ignore them,” saysMosoff.
Bitcoin competitors offer a different set of value propositions that have a legitimate place in the cryptocurrency space and in an investment portfolio, he adds.
It’s early days yet for crypto, and there will be new protocols and applications that disrupt or replace the ones that exist today. “It’s important to constantly be looking at developer activity as a bellwether for where the market may be in 12 to 36 months from now and use metrics like that to decide which assets to invest in,” says Mosoff.
Bitcoin has performed better than most other crypto coins over the last several years, but that certainly doesn’t make it the best, argues Shafrir. “There’s plenty that bitcoin can’t do on its own, like DeFi,” he says, but admits there’s “a strong case for having a large portion of your crypto portfolio in bitcoin.”
Given their asymmetrical returns, diversification benefit and growing adoption, cryptocurrencies merit a place in many portfolios. However, things are moving fast in the cryptosphere. A great new opportunity that doesn’t exist today could pop up in six months.
Alternatively, a cryptocurrency asset that seems like a winner today could have a critical flaw and fall out of favour tomorrow. Staying abreast of the latest news and developments is a big part of crypto investing.
And as with any risky investment, know your limit and stay within it.
