Cryptocurrency: Risks vs Returns

In this blog, I will discuss the below topics –

Understand the notion of return
Learning about the dangers of cryptocurrencies
Observing an example of Bitcoin risk vs. return
Examining several forms of cryptocurrency threats
Adapting your investing approach to your risk tolerance

So you’re delighted to hop on the cryptocurrency bandwagon, possibly because you anticipate a massive profit (return) on your investment. That is, in essence, the benefit of investing. However, you can’t think about a return without thinking about risk. The uncertainty around the actual profit you earn is known as risk.

Due to our different lives and financial conditions, what may be a high risk for me may not be as high risk for you.

Examining Cryptocurrency Profits

Returns are generated in a variety of ways depending on the asset. The change in the value of an investment, for example, is one source of return. Additionally, whether you invest in the stock market or the FX (foreign currency) market, you may get dividends or interest as a result of your investment. These two types of returns are referred to as capital gains (or losses) and current income, respectively, by investors.

Although most individuals engage in cryptocurrencies for long-term financial gains, certain cryptocurrencies can provide immediate income.

Gains on Investments (or Losses)

The most common motive for investing in crypto is to profit from increases in the value of the currencies. Some people link the coins with gold and other valuable metals. It makes sense since, like gold, most cryptocurrencies have a finite supply, and mining is one method to get a large number of them.

As a result, even though cryptocurrencies are technically currencies that can be used in transactions, many investors see them as assets. People purchase these currencies with the intention of selling them at a higher price later. When you sell your cryptocurrency token, if its value has increased since you bought it, you will get capital gains. Congrats! If prices fall, you will experience capital losses.

Income through Crypto

In the bitcoin market, income is a lesser-known sort of return. Crypto dividends are a kind of income that is earned.

Dividends are traditionally paid out when a public company distributes a percentage of its profits to its shareholders. Cash payments, stock shares, and other property are all examples of traditional dividends.

Dividends in the crypto market might be a little more difficult to come by. Separate currencies operate under different systems and have their own set of laws and regulations. The premise, though, stays the same. Crypto dividend payments are growing more prevalent among altcoins, which are cryptocurrencies that aren’t Bitcoin. Consider crypto dividends as well as the possibility of financial gains when selecting a cryptocurrency for your portfolio (discussed in the preceding section).

Crypto dividends may be earned in a variety of ways.

Staking:Keeping a proof-of-stake currency in a unique wallet.

Buying and holding a cryptocurrency in any wallet.

NEO, KuCoin, BridgeCoin, Neblio, and Komodo are some of the dividend-paying cryptocurrencies.

In addition, besides staking and holding, you may receive recurring interest payments by engaging in crypto lending. Allowing organisations like Celsius Network to lend out loans to the general public against cryptos, for example, may earn you up to 5% interest on your cryptos.

Examining Different Types of Risk

Educating yourself about risk puts you ahead of the game. You can build a plan that protects you and your money if you know your risk tolerance. The hazards connected with cryptocurrency may be attributed to a variety of factors. The numerous forms of crypto hazards are listed below.

Risks of Cryptocurrency Hype

Though becoming excited about the prospect of purchasing your dream automobile is a positive thing, the excitement around cryptocurrency isn’t necessarily the same. The major reason for the buzz around cryptos is because most individuals have no idea what they’re buying in and just follow the herd. The fast-and-furious market increase in 2017 was fueled in part by the crypto euphoria. Prices plummeted when consumers realised what they’d spent their money on. This sort of activity grew so common that crypto enthusiasts invented their own vocabulary to describe it. Here are a few words to get you started:

FOMO stands for “Fear of Missing Out,” a crypto-geek word. This occurs when you see a significant increase in the price of a cryptocurrency you don’t own and rush in to buy it as the price rises. Don’t even think about it! Because what goes up must come down, you could be better off waiting for the hoopla to die down and purchasing at a cheaper price.
Fear, Uncertainty, and Doubt (FUD) is an acronym for “Fear, Uncertainty, and Doubt.” In September 2017, Jamie Dimon, the CEO of JPMorgan Chase, propagated one of the largest FUDs by declaring Bitcoin a hoax. He later said in January 2018 that he regretted expressing it.

“All-time high” is abbreviated as ATH. It’s reached an ATH,” you might remark when the price of an asset hits the highest point in its history.

You don’t want this to be your moniker, bag holder. Investors that purchased out of FOMO at an ATH and missed the opportunity to sell are known as bag holders. As a result, they’re stuck with a bag (wallet) full of useless coins.
BTFD: “Buy the f@#&ing dip!” says this one. You must BTFD if you do not want to become a bag holder.

Arm yourself with information about the individual cryptos you’re considering before succumbing to market noise. In the crypto market, you have a lot of potential to earn a lot of money. Rather of banking on the current buzz, stay patient and get the necessary information. An investor who trades on hype is most likely not investing at all.

Lack of Cybersecurity

Scams that pose a security risk. Hacking. Theft. Since Bitcoin’s creation in 2009, these difficulties have been a recurring topic in the cryptocurrency industry. And, with each controversy, the value of cryptocurrencies is jeopardised, if only momentarily. Your cryptocurrency may be hacked in three methods, which I’ll go over in detail in the sections below. Every phase of your bitcoin investment plan should include taking safety measures.

The Cryptocurrency.

Hundreds of cryptocurrencies are currently available for purchase, and thousands more ICOs (initial coin offerings) are expected to launch soon. When deciding which cryptocurrency to invest in, you should familiarise yourself with the blockchain’s protocol and ensure that there are no defects (or reports of bugs) that might jeopardise your investment. The protocol is the agreed-upon set of rules for the blockchain network. On the cryptocurrency’s website, you may be able to learn more about the protocol’s characteristics by reading the white paper. The white paper is a formal document created by the cryptocurrency creators prior to their initial coin offering (ICO), in which they lay out all there is to know about the cryptocurrency. Companies, on the other hand, are reluctant to reveal their flaws in their white papers.

Bugs of this kind may be found in even the most popular coins. For example, when EOS released the first version of its open source software before June 2, 2018, it received a lot of bad news. A weakness in the EOS code was discovered by a Chinese security company, which could potentially have been exploited to manufacture tokens out of thin air. EOS, on the other hand, was able to resolve the issues. To transform the negative publicity into something beneficial, Block.one, the EOS creator, asked individuals to look for unknown flaws in exchange for monetary prizes (a procedure known as a bug bounty).

When a flaw is discovered, trustworthy cryptocurrency issuers should take action right away. However, you should keep your hands off their money until they do!

Cryptocurrency Exchanges

The exchanges are the places where cryptocurrency tokens are traded. You must ensure that your trading host is reliable and trustworthy. Because of the exchanges, there have been several security problems and data breaches in the crypto ecosystem.

One of the most well-known early attacks occurred in 2013, when Mt. Gox, the biggest Bitcoin exchange in Japan, was hacked. Mt. Gox was managing 70% of the world’s Bitcoin exchanges at the time. However, it had a number of flaws, including a lack of a testing methodology, version control software, and adequate administration. As all of these issues mounted, the exchange was hacked in February 2014, resulting in the loss of around 850,000 Bitcoins. The remaining 650,000 Bitcoins were never found, despite the fact that 200,000 were subsequently retrieved.

Many exchangers have taken this disaster as a lesson and are now using the most up-to-date safety procedures. Exchange hacks, on the other hand, continue to occur on a near-monthly basis.

Attacks are more likely to target centralised exchanges.

As time passes, the market learns from its errors and strives to create a better and more secure future. You should, however, take control of the situation as much as possible. Examine the security section of an exchange’s website before deciding. To promote safety, see whether it participates in any bug bounty programmes. And, of course, inquire about the trade with the appropriate individuals.

Risks with Cryptocurrency Wallet

Because the kind of crypto wallet you choose is fully up to you, the last round of security checks is entirely in your control. You can keep your crypto currencies in a safe physical wallet even if you don’t carry them with you. These wallets also hold your public and private keys, which you may use to conduct transactions with your cryptocurrencies. By having a backup, you may increase the security of your wallet.

Risk of Volatility

Volatility risk is the danger of unanticipated market moves. Volatility might be beneficial, but it can also take you off guard at times. The bitcoin market, like any other market, might go in the opposite direction of what you predict. If you aren’t prepared for market volatility, you risk losing the money you have invested.

Many factors have contributed to the cryptocurrency market’s volatility. It’s a brand-new technology, for starters. Initial periods of instability may occur when innovative technologies, such as the Internet, are introduced. Before becoming widespread, blockchain technology and the cryptocurrencies that it underpins need a lot of acclimating.

Looking at the broad picture is the greatest method to fight the danger of bitcoin volatility. If you have a short-term investment perspective, volatility is important since it is a measure of how much money you may gain or lose in a short amount of time. Volatility, on the other hand, might become an opportunity if you have a long-term view.

You may also use automated trading algorithms on several platforms to reduce volatility risk. If the price declines by 3%, for example, you may place an order to “sell 65 percent of coin 1,” “100 percent of coin 2,” and so on. This method may help you sleep better at night by reducing the danger of volatility.

Risk of Liquidity

Liquidity risk is defined as the possibility of not being able to sell (or liquidate) an investment promptly and at an acceptable price. For every traded asset, liquidity is critical. The FX market (my first love) is regarded as the world’s most liquid market. However, even in the FX market, a lack of liquidity might be an issue. If you trade currencies with a little amount of volume, you may not be able to conclude your deal since the prices just won’t change!

Illiquidity may occur with cryptocurrencies as well. Heck, one of the elements that contributed to the extreme volatility of Bitcoin and other cryptocurrencies was the liquidity issue. When liquidity is scarce, there is a greater possibility of price manipulation. By making a large order, one large player may quickly sway the market in his or her favour.

Whales are the term used in the crypto world to describe these large players.

Whales in the cryptocurrency market often use their vast resources to move minor cryptocurrencies.

On the plus side, the market may grow more liquid as bitcoin investment becomes more accessible and accepted. More individuals will be able to trade as the number of reliable cryptocurrency exchanges grows. Crypto ATMs and payment cards are springing up, assisting in the spread of cryptocurrency knowledge and acceptance in daily transactions.

The position of nations on cryptocurrency rules is another important aspect in bitcoin liquidity. More individuals will feel comfortable using and trading cryptocurrencies if the government can clarify concerns like consumer protection and crypto taxes, which will impact their liquidity.

When deciding which cryptocurrency to trade, evaluate its liquidity by looking at its acceptability, popularity, and the number of exchanges on which it has been traded. Cryptocurrencies that are less well-known may have a lot of upward potential, but they may put you in difficulties due to a lack of liquidity.

Risk Disappearing

No, I’m not referring about vanishing into the ever-mysterious blockchain sector. Quite the opposite is true. There are hundreds of different cryptocurrencies available right now. Every day, more and more cryptocurrencies are launched. Many of these cryptocurrencies may perish in 10 years, while others may thrive.

The dot-com bubble is a well-known example of disappearing risk. Many entrepreneurs across the globe dreamt up enterprises that seized on the popularity of the Internet in the late 1990s. Some, like Amazon and eBay, have been successful in conquering the globe. Many more went down in flames. Many of the burgeoning cryptocurrencies cropping up left and right are doomed to fail, according to history.

To reduce the danger of disappearing assets, research the fundamentals of the cryptocurrency you want to invest in. Do you agree with their objectives? Are they addressing an issue that will persist in the future? Who are their associates? You can’t completely remove the chance of disappearing, but you can reduce the risk of a quick bust.

Risk of Regulation

The absence of regulation was one of the early draws of cryptocurrencies. Crypto aficionados didn’t have to fear about governments pursuing them in the good old days. They just had a piece of white paper and a promise. However, as the demand for cryptocurrencies rises, worldwide authorities are left scratching their brains as to how to stay up – and avoid losing their shirts in the process.

Because most digital currencies are not backed by a central government, each country’s rules vary.

The bitcoin regulation risk may be divided into two categories: the regulation event risk and the regulation’s type.

The possibility of a regulatory event does not always imply that the bitcoin market is in trouble. It simply indicates that market participants responded to unexpected news. Every apparently little regulatory news in 2018 pushed the price of several major cryptocurrencies upward and caused a lot of volatility.
Because there are no worldwide cryptocurrency authorities at the time of writing, current rules are inconsistent. Cryptocurrency exchanges are allowed in certain countries (such as Japan and the United States), as long as they are registered with the financial authorities. Some nations, such as China, have imposed harsher regulations on cryptocurrencies while being more forgiving on the blockchain business.

At current time, the future of cryptocurrency laws seems bright, but it may have an influence on the markets in the future. However, as the market strengthens, these effects may become isolated occurrences.

Risk of Taxes

When bitcoin investment initially became popular, few people paid taxes on their profits. There was a lot of underreporting going on. However, as the market becomes more controlled, taxes may become more stringent. Despite the fact that they include the term currency, the US Internal Revenue Service considers Bitcoin and other cryptocurrencies to be property as of 2018. As a result, altcoin transactions are subject to capital gains tax.

If you reside in the United States or are a citizen of the United States, tax risk refers to the possibility that the government may make adverse changes to tax regulations, such as limiting deductions, raising tax rates, or eliminating tax exemptions. Tax risk might be more difficult in other nations. For example, the Philippines’ Bureau of Internal Revenue hasn’t decided whether cryptocurrencies would be taxed as stocks, property, or capital gains at the time of writing.

Cryptocurrency taxation is a murky area, despite the fact that virtually all investments are vulnerable to increases in tax rates. Most regulators can’t even agree on what a token is supposed to represent!

Different nations, of course, have different regulations.

Methods of Risk Management

Only by investing at a risk level compatible with your risk tolerance assessment can you accomplish your financial objectives. You may assess your risk tolerance by examining objective factors such as your investing objectives, time horizons for each goal, liquidity requirements, and so on. Setting longer-term objectives, increasing your money via ways other than online investing, and minimising your demand for immediate liquidity may all help you enhance your risk tolerance.

These are undoubtedly easier said than done, particularly because you never know when you’ll be financially impacted. The parts that follow will show you how to minimise risk by putting money aside for an emergency, being patient with your investments, and diversifying your portfolio.

TOLERANCE TO RISK

There are two fundamental components to risk tolerance:

Your willingness to take a chance

Your willingness to take risks

A financial planner is likely to ask you to complete a risk tolerance questionnaire, which assesses your risk appetite. By inquiring about risk problems, this quiz assesses your willingness to take on risk. It may assist you figure out if you’re a risk taker or a risk taker. To contemplate investing in a greater-risk venture, a risk-averse investor demands a much bigger return. A risk-tolerant investor is more ready to take a minor risk in exchange for a higher return.

However, in order to really grasp how much you can invest in the markets, you must first determine your risk tolerance based on your own financial condition and living circumstances. To figure out your risk tolerance, you’ll need to produce your financial documents and look at certain ratios like the one below.

You may compute your emergency fund ratio by dividing your available cash by your monthly essential expenses. The final score must be higher than 6.
Divide your housing expenditures by your gross salary to get your housing ratio. If you reside in the United States, your score must be less than 28%.
Debt ratio is calculated by dividing your total debt by your total assets. The standard varies according on your age and financial objectives.
Net worth to income ratio is:Divide your net worth (all of your assets minus your debt) by your total assets to arrive at this figure.

You may then fill out a quick questionnaire to determine your risk tolerance by using these ratios and comparing them to benchmark statistics.

Create an Emergency Fund First

I emphasise the need of having an emergency fund, regardless of what you’re investing in or how you plan to invest. Divide the amount of your entire instantly accessible cash by your essential monthly costs to establish your emergency fund. This will tell you how many months you can go without any new financial flow. The duration of the outcome must be longer than six months. The more the merrier, though.

Wait patiently.

The dangers associated with cryptocurrencies vary somewhat from those associated with other, more established markets like stocks and precious metals. Regardless of your assets, you may apply comparable approaches to manage your portfolio risk.

The desire to make wealthy soon is the most typical reason why many traders lose money online.

Our investing group’s motto is “patience is a lucrative virtue.” The bulk of our portfolio was made up of stocks and currency, but Bitcoin investors have had the similar experience. Early Bitcoin investors had to wait years (nine years, to be precise) to see any return on their investments. And, despite a little bubble in 2017, nothing stands in the way of the markets hitting and exceeding all-time highs in the future years.

Long-term investors aren’t the only ones who benefit from the patience mantra. Traders and speculators are also included. That investment or speculative position you chose might move up or down for what feels like an eternity. The market will eventually notice the mood and either reverse losses or offer fresh purchase chances.

Of course, you’d want for the markets to immediately march up to your profit target (or exit) price level. But, more often than not, this is not the case.

A rocky path leads to success. At times, your portfolio may even go into negative territory. However, if you’ve done your homework and thoroughly researched your investment, you’ll need to make patience your friend if you want to see long-term gains.

The 2008 financial crisis is a wonderful illustration of this concept. Because of economic concerns such as the mortgage crisis, almost all markets throughout the globe, including the US stock market, have tumbled like a rock. The majority of individuals were worried and began to sell their assets at a significant loss. They could have had their portfolios in positive territory in roughly five years if they had exercised some (well, a lot of) patience. They would have more than quadrupled the profits on the identical assets by 2018.

Diversify both the exterior and the interior of your home. Cryptocurrency Wallet The “don’t put all your eggs in one basket” concept applies to portfolio diversification, and this age-old investment advice holds true in the innovative cryptocurrency market. Diversification within your cryptocurrency portfolio is just as essential as diversifying your portfolio by adding other assets such as equities, bonds, or exchange traded funds (ETFs).

Bitcoin, for example, is possibly the most famous of all cryptocurrencies, and everyone wants a piece of it. However, since Bitcoin is the oldest cryptocurrency, it has several unsolvable issues. Every day, newer, higher-performing cryptocurrencies enter the market, presenting intriguing chances. (I’m not implying that being younger is always preferable.) I’m not talking about humans here; I’m talking about cryptocurrency!)

Aside from age, you may group cryptocurrencies in a variety of ways for diversity. Some instances are as follows:

The top 10 cryptocurrencies by market capitalization are included in this category. Bitcoin, Ethereum, Ripple, and Litecoin are among the possibilities available at the time of writing.
Cryptocurrencies that are used for transactions: This is the initial category for cryptocurrencies. Transactional cryptocurrencies are designed to be used as money and traded for goods and services. On this list, well-known cryptos include Bitcoin and Litecoin.
Cryptocurrencies for platforms:These digital currencies are intended to eliminate intermediaries, develop markets, and even launch new digital currencies. One of the most popular cryptos in this category is Ethereum. It serves as a foundation for future applications. Another good example is NEO. These cryptocurrencies are often seen to be solid long-term investments since their value rises as more applications are developed on their blockchain.
Privacy cryptocurrencies are comparable to transactional cryptocurrencies, but they place a greater emphasis on transaction security and anonymity. Monero, Zcash, and Dash are among examples.
Cryptocurrencies designed for particular applications: Application-specific cryptocurrencies, one of the most popular sorts of cryptos, perform specialised roles and tackle some of the world’s most pressing issues. Vechain (for supply chain applications), IOTA (for Internet of Things applications), and Cardano are some examples of such cryptos (cryptocurrency scalability, privacy optimizations, and so on). Some go into great detail, such as Mobius, also known as Stripe in the blockchain business, which in 2018 was attempting to fix payment concerns in the agricultural industry. A few of these cryptos may out to be incredibly successful, depending on the characteristics of each project. You may choose the ones that address topics that are important to your heart; just make sure to thoroughly examine their usability, application performance, and project team.

When it comes to diversity, one of the biggest issues the bitcoin market has is that it looks to be incredibly connected. When market sentiment becomes bullish (upward), the majority of cryptocurrencies rise, and vice versa. Despite this trend, you may reduce risk in a crypto-only portfolio by diversifying it with additional crypto assets. You may spread out the amount of risk you’re exposed to by investing in numerous crypto assets rather than having all of the portfolio’s volatility come from one or a few assets.

Conclusion

Cryptocurrencies have demonstrated their fair share of volatility, generating millions of dollars for some investors while wiping out their original investment for others. I outline bitcoin benefits and risk, explain several forms of risk, and provide risk management advice on how to manage risk in the crypto market. Crypto dividend payments are growing more prevalent among altcoins, which are cryptocurrencies that aren’t Bitcoin. Consider crypto dividends as well as the possibility of financial gains when selecting a cryptocurrency for your portfolio. The hazards connected with cryptocurrency may be attributed to a variety of factors.

FUD is an acronym for “Fear, Uncertainty, and Doubt”. Jamie Dimon declared Bitcoin a hoax in September 2017. Your cryptocurrency may be hacked in three methods, which I’ll go through in detail below. Every phase of your bitcoin investment plan should include taking safety measures. Cryptocurrency exchanges are the places where cryptocurrency tokens are traded.

You must ensure that your trading host is reliable and trustworthy. Examine the security section of an exchange’s website before deciding whether it participates in any bug bounty programmes. And, of course, inquire about the trade with the appropriate individuals. You can keep your crypto currencies in a safe physical wallet even if you don’t carry them with you. By having a backup, you may increase the security of your wallet.

This method may help you sleep better at night by reducing the danger of bitcoin volatility risk. When liquidity is scarce, there is a greater possibility of price manipulation. Cryptocurrencies that are less well-known may have a lot of potential. But they may put you in difficulties due to a lack of liquidity. The dot-com bubble is an example of disappearing assets.

Cryptocurrency exchanges are allowed in certain countries (such as Japan and the United States), as long as they are registered with the financial authorities. Some nations, such as China, have imposed harsher regulations on cryptocurrencies while being more forgiving on the blockchain business. Tax risk might be more difficult in other nations. Cryptocurrency taxation is a murky area, despite the fact that virtually all investments are vulnerable to increases in tax rates. That’s why it’s critical to complete your homework on taxes before deciding on an investing plan.

The parts below will show you how to minimise risk by putting money aside for an emergency and being patient with your investments. To determine your risk tolerance, you’ll need to produce your financial documents and look at certain ratios. The standard varies according on your age and financial objectives. Create an emergency fund by dividing your available cash by your monthly essential expenses for a six-figure sum. The dangers associated with cryptocurrencies vary somewhat from those associated with other, more established markets like stocks and precious metals.

Early Bitcoin investors had to wait years (nine years) to see any return on their investments. The 2008 financial crisis is a wonderful illustration of this concept. Diversification within your cryptocurrency portfolio is just as essential as diversifying other assets. Bitcoin, for example, is possibly the most famous of all cryptocurrencies, and everyone wants a piece of it. Every day, higher-performing cryptos enter the market, presenting intriguing chances.

Cryptocurrencies designed for particular applications:. Application-specific cryptos tackle some of the world’s most pressing issues. Privacy cryptocurrencies place a greater emphasis on transaction security and anonymity. You may spread out the amount of risk by investing in numerous crypto assets rather than having all of the portfolio’s volatility come from one or a few assets.