\\\n## What is Risk?\n\nCrypto is an extremely risky world because either you will earn a lot or go on to lose all your money in it. In project aggregators like [Coingecko](https://www.coingecko.com/), we have almost 14000 coins and tokens. Some of them will go to the moon like Ethereum, while others turn out to be a failure like Luna.\n\n !(https://cdn.hackernoon.com/images/b67ixwNT8rhwQOX42x4HdxfwCYF2-7h93nhv.png)\n\nSo, how to navigate in this space? After all, trying to catch the best-performing projects is a difficult and risky task, since it’s very hard to predict success. This knowledge is worth billions, which is why you probably don’t get them even on the most popular YouTube channels available.\n\n\\\nAlthough **the future is a range of possibilities**, we don’t have the data to form a probability distribution. Therefore, we don't know what might happen. However, **the sign of good investors is that they don't forecast the future, rather they possess an above-average understanding of the future tendencies**.\n\n\\\nAlso, **we cannot control the returns that the market provides us**, but **we can always control the risks that we are willing to accept**. The risks can be reduced by limiting available projects to invest in. Although, this may prevent us from ending with scam tokens. Unfortunately, it will also limit us from getting exposure to hyped fast-growing projects like Shiba Inu.\n\n !(https://cdn.hackernoon.com/images/b67ixwNT8rhwQOX42x4HdxfwCYF2-oca3n6u.png)\n\nIt’s always a trade-off, so the first step in our framework is **Understanding Risk** – The balance between losing money and opportunism (gains).\n\n\\\nRisk isn’t equal to **Uncertainty** – A lack of complete certainty, which defines the existence of more than one possibility. The “true” outcome, state, result, and value is not known.\n\n\\\n**Measurement of uncertainty** – Includes a set of probabilities that are offered to a set of possibilities. For example, “There is a 60 percent chance it will be a successful project and a 40 percent chance it won't.”\n\n\\\n**Risk** – It's a state of uncertainty where there are possibilities involving an injury, loss, catastrophe, or many other undesirable outcomes (i.e., anything bad may happen).\n\n\\\n**Measurement of risk** – A set of possibilities each with quantified probabilities and quantified losses. For example, “We believe there is a 40 percent chance the recommended project will be a scam with a loss of $12 million in initial investment.”\n\n\\\n**The main difference between risk and uncertainty is that risk is measurable while uncertainty is not measurable or predictable**. This is the reason why we focus on risk. Let’s check its impacts.\n\n\\\n## Risk Factors\n\nThe concept of risk is hard to grasp because we don’t have all the data to calculate it precisely. No one can calculate the expected rate of return from a random crypto project unless you are a scam token insider...\n\n\\\nIn our consideration, we will mostly focus on qualitative measures. **What is our ability to take the risk?**\n\n\\\n* **Investment horizon** – Crypto is changing rapidly, so it’s hard to calculate the value of a portfolio at a specific point of time in the future. What is your expected time horizon?\n\n \\\n* **Stability of earned income** – How diversified our outside world is apart from crypto? Do we have another stable source of income or uncorrelated investment with cryptocurrency?\n\n \\\n* **Need for liquidity** – How liquidated your investment should be, to cover your unexpected expenditures? By liquidity, we mean how easily can we convert this to cash. It shouldn’t be a problem for crypto projects with high capitalization. It is much more important for [NFTs](https://www.forbes.com/advisor/investing/cryptocurrency/nft-non-fungible-token/).\n\n \\\n* **Options that can be exercised (“Plan B.”)** – What will happen in a worst-case scenario? How does losing all your money impact your life? If you’ve just started, invest only money that you can lose.\n\n\\\nDepending on the given answers, we can estimate our **Risk Appetite**. After all, investment is tightly coupled with this, so we also have to find a way to manage it.\n\n\\\n## Risk Management\n\nRisk management is the process of **identification**, **analysis**, and **prioritization** of risks **followed by coordinated and economical application of resources to reduce, monitor, and control the probability and/or impact of unfortunate events**.\n\n\\\nLet’s dive deeper into a different part of this definition:\n\n\n1. **Identification** – Identifying risks in the initial phases\n2. **Analysis** – Analyzation of potential impact and probability on us\n3. **Prioritization** – Listing risks that are to be dealt based on the importance to us\n4. The rest of the definition can be simplified by **being smart about taking chances**. From an unlimited space of choices, we need to choose those we think are the best for us.\n\n\\\nTo simplify our Risk Management process, we can divide them into 4 different types.\n\n\\\n## Risk Types\n\nRisk can be **avoided**, **managed (mitigated)**, **ignored** and **transferred (insured).**\n\n\\\n !(https://cdn.hackernoon.com/images/b67ixwNT8rhwQOX42x4HdxfwCYF2-zm93mfz.png)\n\n**Avoid** – Risks with a high likelihood of consequences must be avoided. After all, risk cannot adequately be managed or insured for a reasonable price. This is “scam” territory but it can also apply more broadly. Example: meme coins.\n\n\\\n**Manage** – High likelihood items with low consequences form part of day-to-day risk management, which helps you take responsibility for or pay someone to manage on your behalf. Example: price volatility.\n\n\\\n**Ignore** – Items having low likelihood and low consequences are mostly not worthy enough to worry about. The time and cost of management are probably not worth the effort so it is perfectly reasonable to ignore them. Example: architecture risk in mature [Smart Contract Platform](https://www.investopedia.com/terms/s/smart-contracts.asp).\n\n\\\n**Insure** – This category involves items with low likelihood and high consequences, where you should ensure the possibility to improve your risk-adjusted return. At the very least, you should understand all the scenarios with high consequences and what might cause them. Example: smart contract risk.\n\n\\\n## Risks in Crypto\n\nWe just review different risk types that could be applied to all areas. Now we will review the source of risk in crypto. Each of them could be later assigned to mentioned previously risk types. Starting with the most general:\n\n\\\n !(https://cdn.hackernoon.com/images/b67ixwNT8rhwQOX42x4HdxfwCYF2-10a3mwk.png)\n\n\n1. **Macro** – Cryptocurrency market is affected by external factors like Covid or mainly China’s ban\n2. **Market** – Most tokens and coins are correlated, especially when we have a correction\n3. **Chain** – Risk associated with specific smart contract platforms like ETH, SOL or AVAX\n4. **Token** – Tokens like USDT can be emitted on different chains\n5. **Protocol (smart contract)** – We can interact with different protocols (crypto project) via smart contracts\n6. **Strategy** – We can use smart contracts in different ways like using lending protocols\n\n\\\nWe should be also aware of all risks related to [security](https://cybersecurity-magazine.com/the-cybersecurity-risks-of-cryptocurrency/).\n\n\\\n# Risk Management Framework\n\nTo summarize, our risk management framework includes below parts:\n\n\n1. **Risk Identification**\n2. **Risk Analysis**\n\n \n 1. **Likelihood**\n 2. **Consequences**\n3. **Risk Prioritization**\n4. **Risk Management**\n\n\\\n\n---\n\n# What Next?\n\n\\\nIn the next posts, we will check another pillar from [Cryptocurrency Investment Framework](https://cryptoengineer.notion.site).\n\n\\\nStay tuned and follow me on [Twitter](https://twitter.com/CryptosEngineer) to get a sneak peek of what is coming!