Is Investing in Cryptocurrency a Good Idea in 2023?
Here are five recommendations from consultants for reducing
the dangers associated with cryptocurrency investment, whichever you choose.
The failure of the cryptocurrency exchange FTX in late 2022 and the ripple effects it had on other businesses served as a wake-up call for individuals who had previously undervalued the dangers associated with trading in cryptocurrencies.
Sam Bankman-Fried, the CEO of FTX's trading division Alameda Research, was arrested after the company filed for bankruptcy due to problems with leverage and solvency. Worse yet, the entire series of circumstances caused a loss of billions in the cryptocurrency market as investor confidence fell and the market capitalization of cryptocurrencies fell.
Following the demise of the stablecoin TerraUSD (UST) and
its companion token LUNA in May 2022, which already had authorities concerned
about regulating the booming crypto industry, came the FTX controversy and the
accompanying "crypto winter."
In the first half of 2023, cryptocurrency prices in general,
and Bitcoin (BTC) and Ethereum (ETH) specifically, have recovered a little.
This has caused the market capitalization of the cryptoverse to surpass $1
trillion and led some people to believe that the crypto winter is ended. Yet, a
lot of financial consultants continue to advise investors to exercise caution
and limit these assets to a modest amount of their portfolios.
Risks of Cryptocurrency Investments
Recent allegations of fraud and poor management against some of the biggest names in the cryptocurrency industry have shown that warnings from authorities like the Financial Industry Regulatory Authority, or FINRA, and consumer advocacy groups like the Consumer Federation of America are justified.
The CFP Board, also known as the Certified Financial Planner
Board of Standards, claims that there are at least six distinct risks
associated with cryptocurrencies:
- Speculation and volatility.
- Difficulty in evaluating assets (separating facts from hype).
- Custodial risks that may lead to theft or loss.
- Difficulty in valuing crypto assets.
- Unregistered assets and providers operating outside of regulatory frameworks.
- Unpredictable regulations.
In the relatively recent history of cryptocurrencies, these
concerns have become apparent. Prices fluctuate sharply, previously valuable
assets have lost all of their value, and widespread theft and loss have taken
place.
In addition, it is challenging to apply conventional valuation techniques to crypto assets, the regulatory environment has been hazy, and some service providers have operated outside of any established framework.
These dangers might not be sufficient to convince many
investors to steer clear of cryptocurrencies. The CFP Board advises investors
to adopt specific risk management techniques if they want to keep making
cryptocurrency investments. (For a closer look at how financial advisors might
discuss crypto risk with clients, see this booklet from the CFP Board.)
How to Manage Cryptocurrency Risk
The following cryptocurrency portfolio management solutions
can cut down on the risk for crypto investors:
- Diversify your crypto portfolio.
- Choose a credible exchange.
- Use cold storage.
- Do fundamental research on digital assets.
- Keep tabs on the news.
Diversify Your Crypto Portfolio
One strategy for reducing the risk of cryptocurrency volatility is to spread your investments out. To achieve such variety, there are various potential methods:
asset types. While utility tokens like Filecoin (FIL) and Binance Coin (BNB) are examples of cryptocurrencies, payment cryptocurrencies like Bitcoin and Litecoin (LTC) are exchange mediums. Others are stablecoins, such as Tether (USDT). NFTs, or nonfungible tokens, are a different common asset class. A good way to spread the risk is to invest across different asset classes.
case studies Several cryptocurrencies are made for diverse
purposes. The Ethereum network, which facilitates smart contracts and the
development of several decentralised apps, uses ETH as its native currency.
Other cryptocurrencies are helpful for supply chain management, decentralised
finance, and the Internet of Things, among other things.
Industry
Cryptocurrency has been causing a stir and adding value in a
number of areas, including finance, gaming, retail, technology, and social
media.
Location
Crypto projects are being developed by inventors all around
the world. Diversification by geography can help to reduce the risk associated
with a specific area.
Market capitalization
There are large-cap, mid-cap, and small-cap cryptos, much
like with equities. It can be beneficial to diversify among market caps in
order to achieve both stability and growth.
Blockchain platform
Ethereum, Cardano, Stellar, Polkadot and others are
blockchain systems that permit the construction of smart contracts and
decentralised apps. Another method of lowering risk is by diversifying among
them.
Choose a Credible Exchange
By selecting reputable, liquid exchanges with a solid reputation, custodial risks and the risk of investing with unregulated providers can be mitigated.
FTX was the third-largest exchange when it "crashed," proving that this aspect of risk management is not foolproof, but at least it fosters a higher level of confidence than opaque, unheard-of, and illiquid exchanges.
Because it gives investors more flexibility to relocatecryptocurrency investors
their investments if they sense difficulty, liquidity is significant. It should
go without saying that safeguarding capital is more crucial than maintaining an
exchange's allegiance.
Use Cold Storage
Another strategy for reducing custodial risks is cold storage. Wallets that are cold, or offline, are safer than those that are hot, or online.
When buying their crypto assets, cryptocurrency investors
who don't need to buy and sell frequently can move them to a cold wallet; when
they need to make a transaction, they can move them back to a hot wallet.
Do Fundamental Research on Digital Assets
When it comes to investing in cryptocurrencies, the main consideration is: What value does it provide? Although short-term price swings may be influenced by market speculation, a crypto asset's long-term price movements will be determined by the inherent value it offers.
By doing the necessary research to establish value,
investors may be sure they are not overpaying for an asset. The discounted cash
flow (DCF) model, the equation of exchange, relative value analysis, and other
standard valuation techniques have all recently been tried to be applied to
cryptocurrencies, despite the fact that they are scarcely a match for them.
Investors should decide whether any of these techniques can
be used with the particular digital assets they are thinking about.
Keep Tabs on the News
Investors who follow reputable media reports are better able
to see events that have an impact on their investments, such a crypto exchange
beginning to spiral out of control, however they shouldn't act on every
unfavourable news they hear. They will also be aware of the release of new and
revised regulatory frameworks and be able to evaluate assets and exchanges in
accordance with those criteria.
Takeaway
Since cryptocurrency is still in its infancy, nobody knows
what the future may bring. Investors who are optimistic about the future of
cryptocurrency must yet use caution and implement risk-reduction measures.
Investors will also be in a better position to assess their risk tolerance and
capacity after speaking with a financial advisor.