What is risk management
The general concept of risk management came from the traditional financial market.
In a broad sense, risk management means managing financial risks. But in order to manage risks, first of all, you need to know them, understand their nature, origin, and take measures in order to avoid these risks.
Risk management exists not only in the classical stock market, it is present in many areas of human activity. Risk management rules are applied and developed for the banking sector, for example, when lending.
They are in the insurance sector. In order to insure a person or an object, the insurer carefully examines the market situation, how many cars were stolen last year, if a car is insured, what chance is it that a person will get sick or lose working ability if a person’s life and health are insured. And only after a thorough analysis of all the data and statistical studies, a decision is made on the size of the insurance rate.
If the decision is made incorrectly, then the insurance company will either go bankrupt, because too many people will demand compensation, or simply will not be able to sell the insurance, since its price will be too expensive.
Similarly, risks are calculated in the field of financial trading. Over the 600-year history of conducting exchange trading, special rules have been developed to reduce risks that allow traders to trade with the lowest losses and protect themselves in case of losses.
The most famous of these rules:
- The size of one transaction should not exceed 2%
- The amount of losses in one trading session should not exceed 6%
- You cannot keep more than 3 deals open at the same time.
All these rules are collected in special trading textbooks. Despite the 600 year history and a large number of rules, the number of bankruptcies in the stock market does not decrease. Bankruptcies of major players even lead to global financial crises that occur at regular intervals in the world.
The classic stock market is strictly regulated and controlled by the state. It is attended by experienced players with special education and vast experience who are well aware of all the rules of risk management.
The cryptocurrency market appeared only in 2009 with the advent of the first Bitcoin cryptocurrency. There are no specific risk management rules yet. They simply did not have time to develop, since there is not enough experience. All that exists came from the classic stock market and was somewhat modified and adapted to the needs of the cryptocurrency market.
What plane are the risks of cryptocurrencies
If the risks of the classic stock market are understandable and studied, then the risks of the cryptocurrency market have not yet been studied. Despite this, their number is no less than in the stock market.
Consider the main types of risks associated with cryptocurrencies:
- Risks associated with the storage of cryptocurrencies. It’s not enough to buy cryptocurrency, you need to be able to save it. Wallets and exchanges hack. At the moment, there are no reliable ways to store cryptocurrencies. The most reliable way is cold wallets. But in the case of a cold wallet, you can lose the password or it can be stolen from you or make you say the password.
- Risks associated with government regulation and legislation. How many cases have there already been when state bodies and regulators blocked the accounts of the exchange and traders, since they did not pay taxes or for other reasons (laundered money).
- Trading risks. Cryptocurrencies are extremely volatile, their course can both rise and fall.
- Technological risks. Cryptocurrencies and tokens are vulnerable. Hackers can find a vulnerability in the source code and steal a cryptocurrency or token. Experienced users faced a situation when a certain token or cryptocurrency disappeared from the wallet, while the remaining tokens and cryptocurrencies continued to be stored in the wallet. Hackers found vulnerabilities in the code of certain cryptocurrencies and stole them from user wallets.
Types of risks
Misunderstanding by most users, and by many traders, of the blockchain technology itself;
The future development of blockchain technology is unclear what it will lead to;
Lack of economic support for cryptocurrencies and most tokens;
High Bitcoin Dominance Index. In the event of a fall in the Bitcoin rate, almost all cryptocurrencies fall. Diversification in this case is difficult;
Monopolized market. Most Bitcoin is concentrated in the hands of a narrow circle of people. Imagine what will happen if they simultaneously decide to sell all their Bitcoins. The market will crash;
Wrong asset selection. 80% of ICO tokens turned out to be unprofitable. Again, with such statistics no diversification will help;
The government can ban cryptocurrencies at any time;
Lack of legislative framework and tax regulation.
Cryptocurrencies make extensive use of crime. Moreover, new crimes related to cryptocurrencies are constantly appearing.
Money laundering and terrorist financing have been replaced by fraudulent ICOs. At the same time, cryptocurrency continues to be used for money laundering to this day.
Hackers are actively hacking exchanges and cryptocurrency wallets, as they are not able to provide adequate protection. Security systems in banks have been developed and improved over the years. The creators of exchanges and wallets simply do not have the proper experience. And the money is spinning huge.
There is banking secrecy and even having cracked the bank, robbers can go with nothing, since there is no money there. Cryptocurrencies are transparent and any hacker can track how much money is in the wallet or exchange accounts and crack them. Not a single defense will help.
Recently, hidden mining has gained wide momentum. The devices of many users are used for mining cryptocurrency through hidden mining.
Almost all the crimes related to cryptocurrencies have remained undiscovered, hackers have not been found and have not been punished. This provokes criminals to commit new crimes, since nothing encourages crime as much as impunity.
Blockchain technology is still little explored and not understood by many.
At the moment, there are no competent professionals. It takes 5-6 years to learn a specialist at the university. And Bitcoin appeared only in 2009. But the fact is that in order to teach people, you need teachers with extensive experience who defended scientific work, you need textbooks, guidelines. The creation of scientific developments and textbooks takes time. It takes even more time to prepare a competent teacher.
The lack of specialists leads to the fact that cryptocurrencies are created by people with insufficient knowledge and education.
These spaces are used by hackers. They constantly find vulnerabilities in a particular cryptocurrency, exchange or wallet. Keeping money is becoming very dangerous. It is also dangerous to trade, since the exchanges themselves are not safe and can be hacked or hacked at any time.
Basic principles of investment risk management
The basic principles of risk management came from the classic stock market. But cryptocurrencies are very different from stock market assets for the following reasons:
Most cryptocurrencies are economically not provided with anything and have an exclusively speculative nature,
Cryptocurrencies are much more volatile than stock market assets,
There are more than 2,000 cryptocurrencies, while the Bitcoin dominance index is more than 50%, not a single classic stock asset has such a high dominance index,
Monopolization of the cryptocurrency market by large holders of cryptocurrencies (Bitcoin) by “whales”.
Therefore, the application of the basic principles of stock investment risk management in the field of cryptocurrencies is extremely limited and conditional. But there are no own principles of risk management in cryptocurrency trading.
Consider how the basic principles of investment risk management in cryptocurrency trading are applied.
Diversification of deposits. It is necessary to have an investment portfolio consisting of 10-15 assets. But the fact is that the Bitcoin dominance index is more than 50. Therefore, if Bitcoin falls, then other assets fall. Diversification in this case will not help.
Rule 2%. One transaction on the exchange should not exceed 2%. Again, the Bitcoin dominance index makes this rule a little wealthy. If cryptocurrencies grow, then everything grows, if they fall, then all at once. In fact, traders use one, if not all of their assets, then most, for one transaction. The rule of 2% in the pursuit of large profits is rarely observed.
The rule is 6%. If during the trading session he lost more than 6% of the total capital, then it is better to stop trading and not to trade for two weeks. The rule is clever, but the cryptocurrency market is extremely volatile and if you do not trade for 2 weeks, then you can miss out on great opportunities. So this rule is observed in cryptocurrency trading very conditionally.
Do not keep open at the same time more than 3 positions. But this rule in the field of cryptocurrency trading is quite popular and often used. The fact is that if an asset is growing, but traders often spend all their finances on the purchase and further sale of just one asset. Therefore, it is rare when in practice traders spray more than three assets. Yes, and in practice it’s hard to do, since platforms on many exchanges really slow down and even with one asset in practice it’s hard to work and monitor it.
The basic principle of cryptocurrency trading
Work with different exchanges. Diversify deposits not by cryptocurrencies, but by exchange. This is perhaps the only reliable basic principle that most traders have developed with practice. There is no perfect exchange, and there is a big risk of losing all your money on the exchange, so most traders prefer to work with different exchanges.
Leverage and its impact on risks
If you can trade on stock exchanges with a leverage of 1: 1000, since most assets have an extremely stable price, then in the field of cryptocurrencies a leverage of 1: 3 is usually used.
Cryptocurrencies are extremely volatile. The Bitcoin dominance index is over 50%. If Bitcoin falls, then the rest of the cryptocurrencies fall. Therefore, the chance to lose all your money when trading with leverage is extremely high.
Now most traders use leverage to capitalize on cryptocurrencies falling. They immediately change credit money to USDT, the rate of which is stable and pegged to the dollar and are waiting for a further decrease in the rate of cryptocurrencies. After a while, they re-buy cryptocurrency at an already lower rate, settle accounts with creditors, and leave the difference to themselves.
There are currently 14,000 cryptocurrency exchanges and 2,000 cryptocurrencies. You can trade at any time. Day and night. There are no days off for cryptocurrencies.
But most exchanges have a liquidity problem. They simply do not have traders and there is nothing to trade. Soon a situation will arise that the number of traders will equal the number of working cryptocurrency exchanges. Therefore, most traders trade on exchanges with great liquidity.
But on exchanges with great liquidity, there is another problem. During the rise in investment activity, that is, when some kind of cryptocurrency rises or falls rapidly, the exchange platform is very slow and trading is not realistic.
In fact, traders trade at random. They just try to make a deal, buy something or sell something. And then they fix their profits if the platform does not hang. Very often, the trader’s losses are due to purely technical problems. The exchange platform crashed and there is no access to it. If the trader did not have time to conclude a deal, then he lost money.
Therefore, most traders during the peaks of investment activity conclude orders in advance and simply wait for their automatic execution when they reach the set values.
Most of the principles of the classic cryptocurrency stock market do not work.
Their principles of risk management in cryptocurrency trading have not yet been developed. Active trading is carried out against the background of some news or events. At these moments, investment activity is growing sharply.
During a surge in investment activity, the platforms of large exchanges are often inaccessible due to the large number of traders trying to conclude deals. Therefore, you need to have accounts on different exchanges and keep some amounts there. And in the case of sharp jumps in rates, you often have to trade on the exchange where it turns out, that is, where the platform works and does not slow down.
In this case, it turns out that no risk management rules work at the same time, and all the money that is on the accounts on the exchange at that time goes into circulation. At the same time, only the diversification of deposits on exchanges saves.