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3 Potentially Brutal Crypto Risks That Most Investors Are Simply Not Ready for
Experience with stocks won’t help you prepare for these risks.
Whether you are investing in serious cryptocurrency assets like Bitcoin (Bitcoin 2.34%) or Solana(SOL -0.05%) or stupid meme coins like Dogwifhat (WIFE -2.91%), you will have to be ready for the standard set of risks. Volatility, macroeconomic issues, cybersecurity threats and other pitfalls are guaranteed to last long enough, and most investors are at least somewhat familiar with the consequences because they have experienced them before.
There are, however, a number of cryptocurrency-related risks that are less common, but potentially even more deadly to your wallet. Let’s explore three of them so you know what to watch out for and how you might fortify yourself beforehand.
1. Network congestion
Investors accustomed to trading stocks are used to being able to execute their trades whenever they want, as long as the market is open.
When they want to buy or sell stocks, their brokers and the exchange communicate automatically, and the chances of their order being lost in processing are close to zero, even during times when tens or hundreds of thousands of other investors across the market I am going through hard times. trying to execute trades on their own. With cryptocurrencies, this unhindered flow of orders to executions is by no means guaranteed.
More recently, before last month’s network upgrade, Solana’s chain was so congested that more than 75% of transactions failed for days on end. In other words, no one could buy or sell coins on the chain, or transfer anything to or from anywhere. Unfortunately, it is a reality that many investors have been trapped in positions that they would have preferred to sell or increase at the right time.
The best way to defend against the impacts of such congestion is to avoid the short-term tactics that are best described as Trading day rather than investing. If you plan to hold onto your coins for several years, the threat of not being able to transact very effectively for a few days or even weeks becomes much less scary, because your main solution will be to simply wait a little longer. for a long time, which you were planning on doing anyway.
2. Unexpected correlations
Many investors think of cryptocurrencies like Bitcoin as hedges against problems in the traditional financial system and the broader economy.
This makes sense, with a problem like this monetary inflation, which can make assets like cash less attractive over time, unlike Bitcoin with its fixed supply cap and immunity to currency devaluation. So, in theory, holding both Bitcoin and cash diversifies a portfolio such that the total value is more resistant to a major risk that could harm one of the assets within it.
The problem is that the price of Bitcoin is anyway related with many other resources, including with main stock market indices. Check out this chart comparing Bitcoin to Invesco QQQ Fundan ETF that tracks the Nasdaq-100as shown here:
Bitcoin price data of YCharts
As you can see, over the last three years, the Nasdaq and Bitcoin have tended to move together.
For reference, a correlation coefficient of this magnitude is considered very strong, meaning that the two components move more or less in tandem rather than in separate rhythms. Therefore, it is probably not achieved by maintaining the index and holding Bitcoin in the same wallet sufficient diversification to protect the overall value of the portfolio in the event of a downturn.
Be careful: Many cryptocurrencies show correlations with stocks and other more traditional investments, as well as macroeconomic trends and consumer confidence levels, and so on.
Don’t wait for a big problem to occur to diversify the multiple investments you hold. Do your best to hypothesize how and why any cryptocurrency investment you are considering purchasing might have its value linked to other assets, indexes or metrics, and make sure you hedge your purchase with something that is confirmed to be totally uncorrelated and non related.
3. Low liquidity and high slippage
When you decide to buy or sell a stock with a small market capitalizationas an independent investor working with a typical amount of money in a retirement account, there isn’t much reason to worry about the functionality of the transaction itself, as discussed above.
Even if you decide to liquidate your holdings after a big gain, your sale will almost certainly not affect the stock price in any perceptible way. In short, you’re simply not moving enough capital around for it to matter, as there are almost always many different buyers and sellers trying to transact.
But with cryptocurrencies, especially smaller ones, there is absolutely no guarantee that your large buy or sell order will be absorbed by the market.
For example, if you had bought Dogwifhat when its market cap was closer to $10 million versus nearly $3 billion, where it is now, you probably would have had a hard time closing your position after a big gain. The value you would try to convert to dollars would represent a fairly large percentage of the value of your other orders.
In such a situation, your order will experience a huge slippage and you will only recover a small portion of the value you are trying to realize. If you’re not familiar with the concept of slippage, it’s basically what happens when you try to trade with such large volume relative to the value of pending orders that you end up driving the price of the asset up or down, thus (potentially dramatically) reducing your returns.
There are two solutions to avoid this risk.
First, do not invest in cryptocurrencies with very small market caps because it is essentially a gamble and most of them will go to zero anyway.
Secondly, instead of moving in or out of your investments all at once, try it dollar cost averaging (DCAing). If you trade in much smaller portions, you will protect yourself somewhat from the pain of volatility in short-term price movements and will also be totally immune to significant losses resulting from slippage as well.