Crypto Investment: How to Reduce the Risks

According to experts in the established financial fields, until a few months ago all forms of crypto investment were considered a serious risk. It was an unknown quantity. It was a bursting bubble. And then, suddenly, it wasn’t. There are still those who doubt the longevity of the crypto phenomenon, particularly as Bitcoin and Ethereum continue to gather momentum at a considerable pace, but just as in every other field of finance, there are low risk and high gain investment options available. It’s just a case of knowing how to identify the potential risks, and taking steps to limit them — as you would when placing your money in any other form of investment.

In this blog, we’re going to be looking at the various complexities of crypto investment, and the best ways to reduce your exposure to the potential risks.

The Crypto Investment Boom

Although cryptocurrency has been around since 2009, apart from a few lucky people with the gift of foresight, it has only very recently started attracting serious investors. A currency, an investment, and a technology all in one, cryptocurrency holds a three-fold appeal, and it’s this — as well as the potential for massive gains associated with the early investment in a new venture — that has driven the recent crypto boom. Forbes recently described the rapid ascent of cryptocurrency as ‘frightening’ because a) it’s new and therefore unknown, and b) because it has the potential to change the entire face of how money ‘works’.

As anyone who hasn’t been living in a Wi-Fi-free cave for the last several years will know, cryptocurrency began with Bitcoin. But, rather than being devised as a potential money-spinner, the original purpose of the virtual coinage was to ease and expedite online transactions between IT workers — so paying for a designer or developer to reconstruct a website, or put a new piece of code into a machine, without the delays that can be experienced when working with established banking methods.

In 2011 other people started getting on the act, using Bitcoin’s open source code to develop their own cryptocurrencies for their own uses, and from there more and more people saw the potential crypto assets offered in the worlds of both tech and business. It’s this that has led to the recent surge in interest and the growing potential for investment.

At the time of writing, Bitcoin has reached an unprecedented peak, with one coin equalling £6,242.80 (US£8,279.92). In the last year, Ethereum and Zcash have also surged by more than 3,000 percent and 1,000 percent respectively, putting them at a value in the region of £300 per unit. In the same period, Litecoin has gained 700 percent in value, and the likes of Ripple, Dash and Monero are experiencing their own surges as more and more people look to be a part of the next big thing. While all of this is very exciting, the sceptics are right, in that it doesn’t come without risks.

Investors wildly throwing their cash at cryptocurrencies are going to get burnt. But then, the same behaviour wouldn’t leave them unscathed when dealing in fiat investments. It’s all about taking sensible precautions.

How Can You Reduce the Risks of Cryptocurrency Investment?

Perhaps the most obvious thing that you can do to protect your assets while putting them to work is to diversify; don’t put all of your crypto eggs into a single digital basket. If trading cryptocurrency isn’t your full-time job, however, and you don’t have the time to ceaselessly research numerous assets, there are some easier options for the part-time investor to take, while still limiting the risk of loss.

• Cryptocurrency Funds. If you’re used to working with standard investments, you’ll probably already know what a fund is, and this is just taking the same concept and carrying it across to the crypto field. For those of you who are as new to investment as they are to cryptocurrency, a fund is a professionally managed set of assets spread across a diverse range of investments on behalf of multiple clients. The individual investors have no say about the specific portioning and placing of their assets, because that’s what they’re paying someone a lot more knowledgeable in the field to do. Because your assets are joined with other people’s (you still get your full cut of interest, minus the percentage that you’re paying to your fund manager) the fund manager is able to spread them across a huge number of platforms, so although you will experience losses, they will be easily absorbed by the gains that you acquire from other sources. And, of course, the potential for loss is lowered because your account is being managed by an expert.
• Decentralised Derivatives. In traditional finance, options and futures are classed as derivatives. They protect asset holders and business owners against volatility. Until very recently, there has been nothing of the derivatives market ilk in the cryptocurrency world. However, Netherlands blockchain company, DCORP, have created a decentralised platform on the blockchain for trustless derivatives contracts, which means that investors can anonymously create options or futures contracts, without the need for brokers. Because the activity occurs on the blockchain it will remain open and transparent, but it offers a layer of protection against volatility and can lead to an asset’s stabilisation.
• ICOs and Custom Coins. ICOs (initial coin offerings) and the custom coins and tokens associated with them, allow for both the spreading of risk and the increase of potential profit. An ICO is the process by which tech companies (on the whole, although others have begun to get involved) raise funds to forward their business, through the sale of what are, in effect, virtual shares. The majority are related to startups — which can bring their own risks — but the process is becoming more popular among established businesses looking for capital to grow the company further. How does this reduce risk? Because your return is no longer tied up in a single currency; it has been spread and will be influenced by, the success of the business behind the ICO. Choose your ICOs carefully, and you could do very well indeed.
• Hedging. Most people will have heard of the phrase ‘hedge fund’, even if they don’t know what it means. In cryptocurrency, hedging plays exactly the same role as in traditional finance; off-setting potential losses against a companion investment. It’s essentially an insurance policy.
• High Liquidity Cryptocurrencies. Liquidity relates to the amount of an asset in circulation. The more of an asset there is, the lower the impact individual investors will make on the market. So, there are 21 million Bitcoins available (not all have been mined yet), so if you sell your 100 it will make you a pretty tasty profit, but it won’t have a huge impact on the overall market. If, however, there were only 1 million coins available and you sold your 100, the market would instantly drop in response. It may well climb again, but when dealing with low liquidity investments, you are exposing yourself to significant fluctuation.

The Future

After a slightly sluggish start, which in the long-term will probably appear nothing more than the blink of an accountant’s eye, cryptocurrencies have suddenly found the accelerator. More and more are being created — more than 1,000 at the last count, but no one really knows the exact figure — and more and more people are getting on board. No longer a blip, crypto is now viewed as a notable disruptor, to the point that Russia has considered banning Bitcoins, and China’s central bank has banned ICOs, while Switzerland has become known as ‘Crypto Valley’, thanks to the way in which the country has embraced this new financial ecosystem.

Now that crypto assets are becoming more widely accepted, and payment cards are allowing cryptocurrency holders to use their funds for real-world purchases, not just online transactions, we’re reaching a state where there is a blurring of the lines. Digital currencies could soon become interchangeable with their physical, fiat forebears. Some are positing that we’re ultimately moving towards a cashless society, and if/when that becomes the case, today’s cryptocurrencies will provide the base from which all currencies will be formed.

Investing in cryptocurrencies and other crypto assets is not risk-free. But what investment is? If you want your capital to grow you have to put your assets out to work.