Risk Management

A Comprehensive Guide to Understanding Risks in the crypto world

The crypto world has an ocean of wealth that's beautiful both at the surface and down to its greatest depths; but it's also a risky place. As you go deeper into its depths, you accumulate more and more risk. Depending on how prepared you are, you can either get crushed by this pressure or witness the beautiful ecosystems that lay below the surface.

Of course, higher levels of risk typically result in higher rewards; risk and reward are siblings after all. But it's always important to understand what you're getting into. This post will discuss the different levels of risks that investors can either avoid or accumulate while moving through this sometimes unforgiving crypto world.

Risk Level 0 - Inherent Risks of Crypto

<Inherent risks are unpredictable and monumental events and scenarios.>

This is the type of risk that you really shouldn't worry too much about; but it's always there. An example of this would be a the Tetherpocalyspe, an utter mismanagement of the largest stablecoin in the ecosystem, USDT, with which most cryptos derive tons of their value from.

• *Other examples include the dawn of quantum computing, an internet apocalypse, and a world government ban.

• *A real-world example in relation to fiat are the prospects of a nuclear war, World War 3, or the collapse of fractional banking.

Risk Level 1 - Market Volatility

<As history has shown time and time again, crypto can easily lose half or more of its value within a couple of days>

Crypto is well-known to be a highly volatile compared to other markets—expect 5 to 10 percent movements on any given day and as much as 30 percent or more at times. Of course, not all crypto assets have the same volatility profiles and you can mitigate this risks with sound investments. Stablecoins and guaranteed futures contracts are exempt from market volatility.

Risk Level 2 - Human Error

<Human error can be realized by sending your funds to the wrong wallet; forgetting passwords; theft, robberies, or government seizure; uneventful trading; being involved or targeted in an exploit; etc.>

Human error is one of those risks you cannot avoid because...well, you're human! But there are many ways to mitigate this, ie stay the hell away from your crypto!

Risk Level 3 - Counter-parties

<Malicious actors can hack and steal from custodians, platforms, smart contracts, and price oracles that hold user assets>

These are:

1. Centralized Market Exchanges and Centralized Finance Platforms** have central points of attacks that can be exploited.

2. Decentralized Finance Platforms** sometimes run on centralized oracles, and this creates a single point of failure where malicious actors can tamper with the smart contracts.

3. Hot Wallets Aka online wallets, like all things connected to the internet, are vulnerable to cyberattacks.

These third-party entities typically do not carry the same protections as your traditional bank, but trusted platforms invest millions into dedicated professional teams to take security precautions in an effort to prevent attacks. Many of these platforms may therefore have insurance policies in place to hedge against the risk of hacks. However, generally they set a ceiling to the amount of loss that can be covered and or reimbursed. In Defi, many projects are focusing on mitigating these risks through (e.g. decentralized oracles and defi insurance platforms), however, a risks will always remain.

Risk Level 4 - Alternative Assets

<DeFi—and sometimes even CeFi—platforms will provide rewards in a local asset that has it's own market volatility risk>

For example, if you want to earn interest by holding Bitcoin in Polygon's AAVE platform, you'll be earning rewards in Polygon's native asset, MATIC, instead of in Bitcoin. Celcius, a CeFi platform, also provides an option to earn interest rewards in their native asset, CEL.

This can either result in upside risk, if the native asset goes up in value; or downside risk, if the native asset goes down in value.

Risk Level 5.1 - Impermanent Loss

<Impermanent loss is a temporary loss of funds where the liquidity provider has to provide assets in an equal ratio, and one of the assets is volatile in relation to the other>

This risk is relative to a scenario where you just held the better performing coin or token. The more volatile the asset is in relation to another, the higher the risks. A more in-depth explanation can be found here.

Risk Level 5.2 - Liquidation

<Liquidation is the risk of surrendering your funds to an exchange or platform when your deposit reaches a minimum value>

Exchanges or platforms do this to be prepared for possible scenarios where a lender won’t be able to exit a position or access their funds whenever they wish. Thus, they specify collateralization ratios and cap the borrowing/withdrawals.

This is evident among leverage trading exchanges or in defi lending and borrowing platforms. When entering defi, you can entirely skip this step and simply be a liquidity provider; hence, the reason why it's an optional risk alongside impermanent loss.

A final few takeaways:

1. The crypto world is still inherently more risky than most markets.

Remember the crypto market has only been around since 2010. Anything can happen so *never ever EVER invest more than you're willing to lose.

1. If you're going to go deep, make sure you're equipped.

There are ways to explore the depths of the crypto world without getting completely crushed and that's by being equipped with the right mentality, understanding the risks, and making the necessary preparations. Also, understand that there are risks you cannot avoid, this will help you stay vigilant.

1. You can appreciate the crypto world from any angle.

Just as you can appreciate the seas from a distance, or by exploring a coral reef, or by deep-diving into it's depths; you can do the same with the crypto world . Again, just make sure you're using the right tools and strategies. The last thing you want is finding yourself swimming in a seal suit in killer-whale territory.

Understand your risks and stay safe.

tl;dr: The deeper you dive into the ocean, the higher the pressure gets. Likewise, the deeper you go into the crypto world , the higher the risks gets. This is just the way of nature.