Understanding Risks

Before we get into fundamental crypto knowledge, I wanted to quickly call out the primary risks involved for crypto investors, and how to mitigate them. I’m putting this page first, even before the Crypto Fundamentals page, in the hopes that newer folks will not skip over it, and will come into this world with open eyes to both the risks and the opportunity in front of us.

If you’re already familiar with both the risks below and Crypto Fundamentals, feel free to skip ahead to the 3 Waves of Crypto.

Crypto is an asset class that legitimately has 20x, 50x or even more upside potential in the coming decade. This will likely be more opportunity in a shorter period of time than any asset class has provided… ever. So, we really don’t want to try to “time” things perfectly, worry about short term price movements too much, or engage in any kind of short term thinking. We want to focus on the big picture, build a long term portfolio of quality crypto assets, and just ride the waves until we’re free. 🙂

So, before we get into more fundamental crypto knowledge and how to actually do that, let’s first make sure we’ve covered the risks we’re facing here, and what to do about them.

Great investors don’t “avoid” risks, they manage them.

Extreme Volatility

Crypto is highly volatile. On any given day, markets can drop 50% or more if the conditions are right, and extended, 80%+ drop, multi-year bear markets have happened multiple times. This is a feature of crypto, not a bug, and this same volatility is what provides so much incredible upside potential. Developing markets and early technologies always work like this, because human emotions oscillate between extremes. If you try to fight this, you will lose every time. If you learn to flow with it, you’ll be able to not only survive it, but actually benefit from it. While bear markets and hard times will wipe out low quality projects, they consolidate strength in the highest quality projects, that emerge from difficult times even stronger than before. Plus, those big crashes and bear markets are the best times to buy quality assets!

So how can you manage volatility risk?

Don’t buy anything, or with any amount of money, that you wouldn’t be comfortable holding if it dropped 50% in a day, 80% in a week, and stayed there for 4 years. It happens!

Extreme Market Cycles

Expanding on the “extended bear markets” mentioned under Extreme Volatility, it’s important to understand crypto’s history of “4 year cycles”. This follows a pre-programmed event in Bitcoin called the “halving”, when new supply entering the market is reduced every 4 years, and prices historically have begun a new bull cycle after each halving. Market cycles happen in every market, but crypto’s are of course… quite extreme.

For a longer term view, you can things like Plan B’s model for Bitcoin valuation based on Stock-to-Flow here, or read more about Bitcoin’s history and market cycles in general here.

A few things to be aware of here. 1) Plan B’s model has fit Bitcoin’s history startlingly well, but should not be considered gospel, especially as we enter the mainstream adoption phase with more variables at play. 2) While these 4 year cycles have been the history, they will not always be the future for the market as a whole. There will be changes as the market matures, other projects decouple from Bitcoin, and institutional players become a larger force. Cycles will probably extend, become more complex, and more impacted by things that cannot be fully predicted, like world events and the kinds of regulation that are passed.

The future will not be like the past, but it will probably rhyme.

One last thing to call out: Big events often mark the top of cycles, or the top of bull runs within a cycle (like Bitcoin futures going live in 2017, or the Coinbase listing in early 2021). This is because hype is the highest, and market manipulators are at their strongest (we’ll talk more about this in Section 2 under Market Manipulation). So, keep that in mind before you FOMO into the hype of “going straight to the moon!” with everyone else before something like a future ETF listing or other major events!

So how can you manage market cycle risk?

Invest for the long term. Plan to invest and grow through the cycles rather than just trying to time them. Only buy things that are highly likely to survive the crypto winter. If you need to take some profits during the good times, do so, but always be planning for the down cycle. Winter is always coming, and will eventually be here again.

Capital Exposure

It’s extremely important to know and match your own risk tolerance. The risk portfolio of a young single person with a steady income is completely different from an older couple living on retirement savings. For most people, this means keeping crypto to a small portion of your total portfolio, that you can afford to lose, and that you don’t mind being locked up for years during the next crypto winter. If you are taking a larger bet in crypto, or any volatile asset, you can do that intelligently… but you must have an income outside of that to carry you through bear markets.

The risk of major projects like Bitcoin or Ethereum going to zero decreases every year, and there are plenty of other promising projects that are likely to survive for the foreseeable future. However, low quality projects will be washed out in the next bear market (statistically this is probably 95%+ of the projects in crypto), and the risk of your portfolio getting cut in half (or more) and being stuck there for years, even with high quality projects, is always present. If you put yourself in a position where you have to sell when the markets are down, it doesn’t matter if you’re right in the long term, you can’t stay in the game long enough to actually benefit.

In addition to this, you should never use leverage in crypto. Whether this is via a trading instrument, futures, borrowing money to buy crypto, or other kind of derivative… just don’t do it. Crypto is volatile enough as it is, there is plenty of upside already, you don’t need to add more risk to the equation. The vast majority of the time, when someone truly decimates their life in crypto, stocks, gambling, etc, they were betting with money they didn’t have, or trading options they didn’t understand.

So how can you manage capital exposure risk?

Only invest money you can afford to lose. Never use leverage. Never put yourself in a position where you have to sell in a down market. Never buy something you don’t understand. Never bet on the market respecting your timeframe. Buy and hold for the long term, and let the future unfold in its own time.

Scams & Hacks

While you can never fully remove the risk of hackers or scammers in crypto (or anything on the internet), a few simple things can keep you from 99% of these threats. I’ll cover this topic and link to some additional resources later in Section 3, under Buying & Storing crypto, but for now let’s just say that while these risks are very real, they are also very manageable, and you’ll probably end up being a more security conscious user of the internet as a result.

So how can you manage the risk of scams & hacks?

For scams: trust no one online, stay alert, and if it seems too good to be true, it probably is. Most scams follow similar patterns. For example: “crypto giveaway” schemes that involve you sending funds to them are almost always fraudulent. Another common tactic is fake accounts that impersonate channels or sites you trust, and ask you to send them crypto or private information. Legitimate sources will never ask you to send them crypto or your private information — if someone asks for this, run!

For hacks: If you’re a beginner, use a trusted custodian with all the security features turned on (whitelisting addresses or withdrawals turned off, Authenticator App, enhanced verification required to withdraw, etc), or if you’re more advanced, learn to self-custody your crypto.