Is investing in cryptocurrency a good idea in 2023? | Cryptocurrency

[ad_1]

For those who underestimated the risks of investing in cryptocurrency until recently, the collapse of crypto exchange FTX in late 2022 and its domino effect on other businesses was a wake-up call.

The leverage and solvency quagmire associated with Alameda Research, the trading arm of FTX, led to its bankruptcy and the arrest of CEO Sam Bankman-Fried. Worse still, the whole series of events resulted in the loss of billions of dollars in the cryptocurrency market, as investor confidence waned and the crypto market capitalization plummeted.

The FTX hubbub and ensuing “crypto winter” followed the fall of stablecoin TerraUSD (UST) and its companion token LUNA in May 2022, which already had angry officials regulating the fledgling crypto industry.

Cryptocurrencies as a whole, and Bitcoin (BTC) and Ethereum (ETH) in particular, rebounded a bit during the first part of 2023, sending the cryptoverse’s market capitalization to over $1 trillion and prompting some to speculate that the crypto winter is over. But many financial advisers still advise investors to err on the side of caution and limit such investments to a small portion of their portfolios.

Risks of Cryptocurrency Investments

Recent accusations of fraud and accusations of mismanagement among some of the biggest names in the crypto world have demonstrated that the alarm bells raised by regulators such as the Financial Industry Regulatory Authority, or FINRA, and consumer protection agencies Consumer Federation of America, for example, are well founded.

According to the Certified Financial Planner Board of Standards, also known as the CFP Board, there are at least six specific risks associated with cryptocurrencies:

Speculation and volatility. Difficulty evaluating strengths (separating facts from hype). Custody risks that may result in theft or loss. Difficulty valuing crypto-assets. Unregistered assets and suppliers operating outside regulatory frameworks. Unpredictable regulations.

These risks have become evident in the relatively short history of cryptocurrency. Prices rise and fall dramatically, assets once thought valuable have lost all their value, and thefts and losses have occurred on a massive scale.

Additionally, traditional valuation methodologies are difficult to apply to crypto-assets, the regulatory framework is uncertain, and some providers have operated outside the established framework.

These risks might not be enough for many investors to close the door to cryptocurrencies. However, the CFP Board recommends that investors adopt certain risk management strategies if they wish to continue investing in crypto. (See this brochure from the CFP Board for an overview of how financial advisors can manage crypto risk with clients.)

How to Manage Cryptocurrency Risk

The following cryptocurrency portfolio management strategies can reduce risk for crypto investors:

Diversify your crypto portfolio. Choose a credible exchange. Use a cold room. Do fundamental research on digital assets. Keep an eye on the news.

Diversify your crypto portfolio

Not putting all your eggs in one basket is a way to manage the volatility risk associated with cryptocurrency. There are several ways to achieve such diversification:

Asset classes. Cryptos such as Bitcoin and Litecoin (LTC) are mediums of exchange (payment cryptocurrency), but Filecoin (FIL) and Binance Coin (BNB) are examples of utility tokens. Still others, like Tether (USDT), are stablecoins. Non-fungible tokens, or NFTs, are another popular asset class. Spreading your investments across multiple asset classes is an effective way to spread risk.

Use case. Different cryptocurrencies are designed for various uses. ETH is the native currency of the Ethereum network, which supports smart contracts and the creation of various decentralized applications. Other cryptocurrencies are useful in decentralized finance, internet of things, supply chain management and more.

Industry. Finance, gaming, retail, technology, and social media are some of the industries where cryptocurrency has made waves and added value.

Location. Inventors around the world are developing crypto projects. Geographic diversification can also be a way to minimize the risks associated with a particular region.

Market capitalization. Like stocks, there are large-cap, mid-cap, and small-cap cryptos. Diversification between market caps can be a good way to combine stability and growth.

Blockchain platform. Ethereum, Cardano, Stellar, Polkadot and others are blockchain platforms that facilitate the creation of smart contracts and decentralized applications. Diversifying among them is another way to reduce risk.

Choose a credible exchange

Custody risks and the risk of investing with unregulated providers can be managed by choosing well-established, credible and liquid exchanges.

While this aspect of risk management is not foolproof, FTX was the third largest exchange when it “collapsed”, at least it brings a higher level of trust compared to obscure, unknown and illiquid exchanges .

Liquidity is important because it puts investors in a better position to move their assets elsewhere if they sense trouble. It goes without saying that capital protection is more important than stock exchange loyalty.

Use cold storage

Cold storage is another way to manage custody risks. Cold or offline wallets are safer than hot or online wallets.

Crypto investors who don’t have to buy and sell regularly can switch to a cold wallet after buying their crypto assets and put them back into a hot wallet when they want to make a trade.

Do fundamental research on digital assets

When it comes to investing in crypto, the key question when considering an asset is: what value does it provide? Although market speculation can influence prices in the short term, it is the fundamental value provided by a crypto asset that will determine its price movements in the long term.

Investors should ensure they are not paying too much for an asset by doing the necessary research to determine the valuation. Although traditional valuation methods hardly correspond to cryptocurrencies, there have been recent attempts to apply some of them to crypto: implied value analysis, discounted cash flow (DCF) model , equation of exchange, relative value analysis and other methods.

Investors should determine for themselves whether any of these methods can be applied to the types of digital assets they are considering.

Keep an eye on the news

While they shouldn’t jump at every negative report they hear, investors who follow reliable media reports are better equipped to detect events that affect their investments, such as a crypto exchange starting to go off the rails. They will also know when new and updated regulatory frameworks are released and can judge assets and exchanges against those standards.

To take with

Cryptocurrency is still in its infancy and no one can be sure what the future holds. But investors optimistic about the future trajectory of crypto should always exercise caution and adopt strategies to mitigate risk. Talking to a financial adviser will also put investors in a better position to assess their capacity and tolerance for risk.

[ad_2]