How to Manage — and Understand — Risk Tolerance in Crypto Investing
Do you understand your tolerance for risk? Being armed with this knowledge is essential — especially if you’re interested in crypto.
“Risk tolerance” is a buzzword that’s commonly bandied around in the investment world — and with very good reason.
Although the phrase “no pain, no gain” has some truth — and there will always be some risk associated with making investments — we all have different thresholds of pain to consider. While some will suffer sleepless nights after the value of their portfolio slides by 1%, others can happily grin and bear it following a 10% hit.
The art of risk tolerance involves understanding your emotional response to financial losses and considering your long-term goals. Whereas turbulence in an asset class might not matter all that much if you’re planning to invest for a few decades, it could prove disastrous if you were saving for a short-term goal, such as a house or a new car.
The crypto dimension
Things get even more complicated when crypto is thrown into the mix. Compared with other assets, digital currencies are susceptible to far more levels of volatility. Just take a look at 2017, when total market capitalization soared from $18 billion to more than $825 billion — an increase of almost 4,500%.
Of course, such extraordinary levels of growth aren’t sustainable. In 2018, the crypto market fell hard and fast — losing 80% of its value in eight months. This decline led to naysayers warning that Bitcoin (BTC) wouldn’t be around for long, not least because the crash was more severe than the one that burst the dot-com bubble in 2000.
This volatility has led to critics warning that cryptocurrencies are impractical for everyday purchases, let alone as investments. Others, like Mike Novogratz, the CEO and founder of Galaxy Digital, think differently. The crypto advocate has claimed it is “almost irresponsible” not to invest in Bitcoin — once telling CNN: “It's almost essential for every investor to have at least 1% to 2% of their portfolio in crypto.”
Novogratz’s sentiment has been echoed by the likes of Tim Enneking, the managing director of Digital Capital Management. He told Forbes that investors are fools if they don’t invest in crypto assets — but added the all-important caveat that they are fools if they invest too much. He also recommended a threshold of 2% for everyday investors, rising to 5% to 10% for enthusiasts. Enneking cautioned that anything beyond this “should be reserved for true experts and devotees.”
Such modest allocations to such a burgeoning asset class might seem surprising, but this is based on the significant health warning that those who invest in crypto should be prepared to lose everything. By devoting a small chunk of their capital to digital currencies, the rationale is that they will be well-positioned to enjoy any substantial price rises that happen in future — and, if their holdings head in the other direction, most of the portfolio will still remain standing.
Individual concerning stability and preserving their wealth would avoid high-volatility investments, hence, those who participate in the cryptocurrency market are considered to be risk-takers. It is worth bearing in mind that volatility means different things to different people — and it can take time for markets to settle down. Taking the dot-com boom as an example, it’s fair to say online businesses had their fair share of turbulence before the stock markets began to calm down. As a result, it could be argued that it’ll just take a while for the crypto world to get settled.
Factors in risk tolerance
So yes, there are some risks associated with holding cryptocurrency as an investment. But given its high volatility, the regulatory uncertainty that surrounds exchanges in some parts of the world, and the danger that hackers and cybercriminals pose, aspiring investors also need to consider their appetite for risk when it comes to unexpected events. Thinking objectively about how much money is being held in crypto — and asking yourself whether you could comfortably lose it — is a straightforward way of gauging risk tolerance.
It is also worth bearing in mind that there are some opportunities that can help reduce the risks associated with crypto trading. One such example is arbitrage. Calendar spread arbitrage is a common hedging practice that takes advantage of discrepancies in extrinsic value across two different expiration contracts of the same token, in order to make a risk-free profit. If Exchange A is selling Bitcoin at $10,200 and Exchange B is selling Bitcoin at $10,500, it could be possible to buy it from the cheaper platform and sell it instantly on the more expensive one, pocketing the difference.
Devoting yourself to researching this ever-changing market can also work wonders for your risk tolerance — both because you can develop an understanding of where risks lie in crypto investments, and the best ways of mitigating them.
OKEx says it aims to deliver as transparent a crypto exchange as possible. Earlier, it launched Futures & Perpetual Swap Market Data , ”the first-of-its-kind big data platform in the industry offering accurate, unbiased trading data for customers to understand the derivatives market.” Additionally, the company suggests a plethora of materials that can help investors find a strategy that’s right for them and manage risk. Thorough blog posts explore technical indicators, analyze why certain assets are underperforming, offer advice on how to hedge portfolios, and deliver tips on how investors can safeguard their holdings against theft.
Recent examples saw OKEx explore whether accepting a salary in crypto is a good idea, following on from New Zealand’s decision to legalize wage payments in digital currencies. Against a backdrop of thousands of retail outlets beginning to accept crypto, the blog noted that such innovation could protect employees against the threat of inflation and the potential financial impact that an economic downturn might bring.
As discussed, eliminating risk entirely when dealing in crypto is a big ask. Experts can barely agree on what causes Bitcoin prices to rise when it’s happening, let alone what’s going to happen in the future. However, by understanding your tolerance levels, thinking about where you want to be in the future, and arming yourself with the tools to spot opportunities and warning signs, it is possible to fashion a strategy that’s a perfect fit.
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