What Can Go Wrong In Crypto Trading?
Trading is a process of selling or buying assets, and here, the asset is a cryptocurrency like Bitcoin, Ethereum, etc. There are so many asset types in terms of crypto coins. However, like in every trading activity, there’s a risk of losing assets because of different reasons related to market, economy, and finance.
With this guide, you’ll understand the risk of crypto trading and how to manage them appropriately. But before delving into the details, if you plan to trade cryptos, you better understand and accept that risks are inevitable.
Why are risks inevitable?
Are cryptocurrency risks avoidable? You might be ready to manage or mitigate possible risks, and your approach may have more or less positive outcomes. However, not all risks are possible to solve or find solutions to. But what makes risks inevitable?
- Volatility issue: market’s sentiment changes may affect the prices of cryptos both negatively and positively. Yet, fluctuations make your coins drop in prices out of sudden.
- Decentralized cryptos: since the concept of cryptocurrencies is quite recent. Still, there’s a lot to catch up with. However, this currency type isn’t controlled either by banks or governments.
- Coins vulnerability: cryptos can become victims of hacking or just human mistake, nothing is set in stone. More to be explained later in this article.
5 basic steps of risk management
Managing possible risks is a common process for people. Yet, in trading, such risk management takes a different shape and approach. It’s more like a framework explaining and guiding investors or traders according to the stipulated steps. In the case of cryptocurrencies, it’s about handling possible loss, which is inevitable in business.
An interesting rule in crypto trading is about not risking more than you may afford to risk. Still, it’s critical to have the best possible approaches. Although they may vary from one situation to another, you may employ 5 steps in risk management:
- Setting objectives. Set your main goal in your trading. Once you’ve decided upon your aim, you accept the possible risks to come and grow tolerance. In other words, you determine how much of the risk is possible and tolerable by you.
- Identifying risks. What are the possible risks? With this step, you try to forecast the sort of problems that may occur. It’s also about gathering information on the possible event on the market that may have a negative impact.
- Risk assessment. If you’re successful with the previous step, it’s time to assess the severity of the risks. You also have to determine how often such events may occur. Such an approach may lead to coming up with a possible response or solution.
- Defining responses. Each event presupposes a particular solution or response. Establish your actions according to the problem occurring to you. It’s important to set solutions given the frequency and severity of the unfavorable events.
- Monitoring. Upon completion of the first 4 steps, you’re to monitor how effectively your responses act. The burdensome part of this step is to gather a lot of data and analyze it.
Main crypto trading risks
For successful risk management, you better understand the possible negative prospects. To know the reasons for the risk is one thing, but to categorize them is different. There are major risk types you should always know to have a better approach to risk management.
When you plan to trade or invest with your cryptocurrencies, you better be sure you fully understand the possible risk that may entail. One of the biggest risks that you may come across is the investment one.
This is related to trading or investment activities, a common problem, especially among beginners. Here, the main problem is associated with fluctuations in the market. The following market, liquidity, and credit risks are under this category.
Market has a risk of volatility that’s hard to predict. Imagine you buy crypto on the platform, and sudden fluctuations may lead to your crypto asset’s price drop. If you’re well prepared as a trader or investor, your risk management will assess the possible losses. Then, you might need to develop a strategy to deal with such volatility in the market.
When you face risks with the market fluctuation, it’s considered to be a direct market risk. However, the more intrinsic risk is about losing when the interest rates may increase. Such risks are considered indirect ones. Even though rates may affect your risk indirectly, the outcomes may be direct.
Liquid market is another major risk you may face while trading or investing with cryptocurrencies. When you can’t buy or sell your assets quickly enough without a sudden change in the price. Again, here, the market determines a lot.
For example, you buy 100 coins for $100 each. So, you keep track of the quite stable market, and your assets’ prices are still for $100. When the market’s liquidity is high, you may sell your coins quickly, as there are many willing to buy them.
However, the market may have low liquidity as well. The cryptocurrency risk here is that you won’t have enough people willing to pay $10,000 for your coins, an illiquid market situation. Therefore, you may have to lower the prices of your assets and lose a possible profit.
This risk may lead to quite global problems worldwide. To put it simply, if you lend some money to a person, you face a credit risk. If that person goes bankrupt or defaults, you lose the lent asset.
Imagine such a case on the national level. That may cause great problems, and some of such credit risk led to the Great Recession in US history. So, a default may lead to the loss of assets, the risk hard to predict.
This type of risk is the one that makes you rethink how you choose your platform and wallet for your crypto coins. Are cryptocurrencies safe? People tend to believe that they are. But no one is safe from accidental human mistakes or fraudulent activities.
Operational risks are possible failures of the system caused by human mistake, or your assets may simply be hacked. Thus, if you’re new to cryptocurrency and trading, you better have your own research on which platform to pick.
The better option to avoid such risk is to have such systems checking and auditing their security and staff quite regularly. Since the notion of cryptos is new and decentralized, you better be cautious.
Complying with laws and regulations is crucial. Failure of compliance also leads to asset losses. Thus, nowadays, many companies have legal procedures known as AML and KYC. So, if you want your coins to be safe, get to know them.
Anti Money Laundering (AML) is a term of the laws regulating illicit activities online. It protects from illegal means like tax evasion, corruption, unlicensed money transfers, market manipulation, etc. US-based agencies such as SEC (Securities and Exchange Commission) or CFTC (Commodity Futures Trading Commission) give all sources for brokers or merchants to set all standards of AML.
Know Your Customer (KYC) gathers all needed information about the possible clients. Here, like AML, the main purpose is to prevent illicit activities. KYC requires any prospective customer to provide the following:
- Photo ID or driver’s license
- PAN and Voter ID cards
- Social security number
- Address verification
Don’t forget that not all platforms require AML and KYC. When it comes to the crypto exchange or trading, you may have limited functionalities without providing all the required information.
If the system collapses, the negative impact will be inevitable. What’s hard to control is how the market system functions and what might happen tomorrow. In other words, you may compare it to the domino effect, when one piece falls, the others will follow the same path.
When considering bitcoin benefits and risks, it seems that it’s more stable and less vulnerable to the systemic risk. However, it’s hard to predict the outcomes of the bitcoins during the crisis. The effects might be surprising, as it was with the metal industry during the 2008 Financial Crisis. Yet, there’s always a risk of losing your bitcoin assets in price and liquidity.
What is the difference between systemic and systematic risks?
The economy and finances might be affected by both systemic and systematic risks. Yet, it’s essential not to confuse these terms. The former means the risk of the system collapse, a cascading effect. It’s more related to larger economy failure, and thus, leading to crisis and recession.
Systematic risk is related to several factors contributing to a negative impact on finance and economy. For example, such risk factors may include interest rates, wars, cataclysms, etc., also known as an aggregate risk. Such risk affects different spheres of the country.
Why having proper trading strategies can minimize your risks?
Having proper strategies is key in trading your cryptos. Given all the dangers of cryptocurrency, it’s not always possible to manage and mitigate the risks. However, not having strategies will make you lose all your assets or something close to that.
Why is it so crucial to have strategies for possible risks? With them, you’ll understand how to:
- accept possible risks and losses, making you more focused and attentive.
- understand fees and expenses on crypt trading that should be considered along with risks.
- focus more on winnings rather than on your losses, which will help you stay motivated.
- calculate and assess your possible losses and winnings.
- know your risk measurement, drawdown measurement, which should be no more than 6%.
Knowing and managing your risks is primarily about being decisive and ready. All calculations, assessments, and predictions should be made carefully. The market is sentimental and vulnerable, but you better be the opposite, so not to lose it all!