How to manage crypto investing risks for new investors

It seems like everyone in crypto has a war story they like to tell about the time they lost a bunch of coins because of some rookie investment move. But I think the one about UK IT Engineer James Howells who dumped 7500 Bitcoin on a hard drive back in 2013 takes the cake. He lost a measly $361 million at today’s Bitcoin price. The moral of the story for the crypto uninitiated? Losing your coins is just one of the many crypto investing risks for new investors. So before you invest your hard earned into the space, we’re here to help you get informed on what it takes to invest successfully in crypto and get to financial freedom.

Hopefully you come out the other side of this article with the know how to bag a fat stack of coins and to keep them.

What do we mean by cryptocurrency investing?

As a new crypto investor, it’s likely you’ll start off with more straight forward types of crypto assets so we’ll focus on those. By crypto investing, we mean investing in cryptocurrency projects that have associated coins and tokens.

We also mean investing in Decentralised Finance products and services to earn interest on your cryptocurrency assets.

We are not talking about complex crypto day trading, margin trading, futures trading or options trading.

Is crypto risky?

Yes it is. It’s new technology and the market is largely unregulated. Crypto assets are also non-custodial. These features can heighten crypto investing risks for new investors if you don’t understand the investing landscape.

However, we would argue it’s also risky NOT to invest in crypto!

Cryptocurrency, in its decentralised and non custodial design, aims to be an alternative to the awful global monetary and financial policy we’ve suffered since the GFC. Crypto is also about more than the coins themselves. It’s about disruptive technology that is here to stay and that we think will shake out some large industries, with finance being just one.

The point we’re making in this post is that you can still invest and manage risk. That’s why we’re sharing everything we’ve learned and do to identify and manage our crypto investment risk exposure.

Know before you invest in crypto that you are in control and that’s the way the ecosystem is designed! No-one is responsible for actively managing your assets and your investing risks but you.

Is the risk worth it? It has been for us because it’s still early stages and we argue the technology development curve is yet to hit exponential growth. But you make up your own mind, hopefully after considering the risks and how to manage them.

Why do you need to know how to manage crypto investing risks?

Because cryptocurrency is non-custodial and decentralised. There are no middle men to transact for your or look after your assets. You need to do this yourself and if you don’t understand how to manage the risk of being custodian of your own money, then it’s likely you’ll fail at that important task.

Besides, there is little to no regulation to fall back on if something happens to your coins. There are no government bank guarantees and very few consumer protections in crypto. And that’s the way the industry likes it. It’s an asset class designed around non-intervention of governments and middle men. All of this means you have to know how to take care of your assets yourself. The way it should be!

If you are a first time cryptocurrency investor, you’re probably new to crypto market idiosyncrasies. Have a read of this post about what makes cryptocurrency prices rise and fall. If the concepts are new to you then it’s super important that you learn how to manage risks because your risk profile is high as a newbie investor.

Risk comes from not knowing what you’re doing.

Warren Buffet

You also need to know how to manage crypto investing risks because as an asset class crypto is potentially one of the greatest asymmetric investment opportunities out there right now. Asymmetric investments are when you risk a small amount of capital for the opportunity to earn much larger returns. This is entirely possible in crypto – we’ve seen it ourselves.

13 crypto investing risks for new investors and how to manage them

Here are our top 13 crypto investing risks for new investors and how to manage them:

1. Price volatility – price swings in the double digits daily
2. Illiquidity – you buy in to an asset but can’t sell it when you need to because trading is too thin
3. User complexity – technical complexity of blockchain transactions for new users
4. Crypto exchange crashes – platforms go down with your crypto on them
5. Project collapse – and the associated coin and token goes with it
6. Hard Forks – a project splits and so does the value of the coin or token
7. Smart contract failure or hack – hacks are rife and often unrecoverable (or at least uninsured)
8. Regulatory risk – risk of non-regulation and new regulation
9. Human error – goes with the technical complexity of crypto
10. Market manipulation – whales throwing their weight around causing prices to pump or dump
11. Theft or hack – physical or cyber, how do you protect yourself?
12. Scams – mostly online and completely insidious, millions have been lost this year alone
13. Rug pulls – DeFi fly by night operators absconding with your treasured coins

Now read on to learn about each risk and how you can protect your crypto assets….

1. Price volatility

The price volatility of crypto is enough to put hairs on your chest. But what is price volatility anyway? Investopedia sums it up as the range of price change a security experiences over a given period of time. Now check out this epic chart from the guys at Trading View showing Bitcoin volatility over two historic market periods – 2017 and 2021. Price corrections of between 20% and 50% are run of the mill for BTC.

It’s worth understanding in context that Bitcoin is less volatile than other small cap coins. So you get the picture – volatility is real in crypto with coins capable of moving hundreds of percent in a day. If you can’t take the heat stay outta the kitchen.

But what are the actual risks of price volatility for an investor? Good question right! The price may move up or down dramatically, but this can be as beneficial to investors as it is risky. It all depends on your entry and exit as well as your investment horizon. If you buy the dip, then price volatility can be totally fly. But if you buy the top it can crush you.

Here’s how to manage your risk

Learn how to read a price chart and charting indicators. Understand from the chart what part of the market cycle you are investing in. If you have a clear view of this, short term volatility is less draining emotionally. For example, if you’re riding a mark down phase (which would be dumb, but it happens) you’re going to be more worried about price volatility (compounding losses) than you would if you’re in a mark-up phase.

Set an investment plan before you invest. What is your aim and your timeframe? What is your break point?

Use trading tools like stop losses to avoid price crashes if you’re not investing for the long term.

If you’re an anxious investor, set your stop losses and don’t check your coins every other day! In crypto there’s ‘weak hands’ – investors that don’t have the conviction of their investment plan and sell out with price weakness, which is inevitably selling at the wrong time. There’s also ‘diamond hands’ – investors who are undeterred by large swings in price.

Which one are you?

2. Illiquidity

Crypto has a low barrier to entry which means that new projects, with their own coins and tokens, are popping up all the time. Some crypto assets, particularly the new projects with micro or small market capitalisation, are traded very thinly. If you’re looking to invest in these projects there’s not a lot of volume. This all means it can be hard to find a buyer or someone to trade with if you want to sell or swap your investment. Particularly if you’re selling at a volatile time.

Here’s how to manage your risk

When you buy a crypto asset, ask yourself “Will i be able to sell when the time comes”? “What is my exit strategy?”

Buy assets that are well traded on exchanges with large volume. This may prevent you from buying some micro caps that are only available on smaller centralised or decentralised exchanges. But that’s the risk mitigation bit in force. If you do buy thinly traded crypto you should understand how to time your exit and sell in small amounts, such as by using bots, to offload your investment. This is also good practice if you have a bag full of the asset and you don’t want to tank the price as you sell down your holdings.

3. User complexity

Crypto is still an early adopter asset. The technology is nascent. This means it’s not necessarily user-friendly to transact with. I remember the first time I sent some crypto through cyberspace I was freaked out. I only sent $100 worth because I wasn’t sure I’d done it right and didn’t trust the technology. But the crypto arrived and the rest was history.

Seriously though, if you ask any crypto investor the first time they put money into a new product, service or protocol there is always that nervousness about how to make it work. Seeing your money disappear into cyberspace when you’re not completely sure it’s going to reappear where you want it to can be heart stopping.

The thing to understand is that crypto transacting is different to bank transacting. It uses different processes and technology and you have to get used to that. Banks have had years to perfect the simplicity of their services (and many still haven’t got it right). Crypto on the other hand has been around for a couple of decades and until 2020 has been the bastion of super brainy IT nerds and tech savvy gamers. There’s been no driver until now to make it user friendly and that means in most cases it’s still involves a learning curve.

Here’s how to manage your risk

The best way to overcome user complexity is by learning the technical and market basics.

Read up on the information we have posted about how to make money with cryptocurrency here and here. Follow these tips on managing risk as you learn the ecosystem:

• Crypto investing – Use the financial service providers you do know – like Paypal – to start investing in larger cap crypto assets like Bitcoin. Paypal provides an ‘on-ramp’ to crypto that many people will recognise and be able to use easily on first attempt. If you do use these conventional on ramps to start your investing just know that you will be paying a premium on the exchange rate from fiat currency into crypto. Think of it as the price of convenience but once you learn how to navigate the ecosystem there cheaper ways to transact.

• Making money with DeFi – start with Stablecoin interest earning products. These are simple to understand as they’re just like bank interest. The least complex way to do this to sign up for a Celsius account and download the app on your mobile phone. If you’re worried about where to buy Stablecoins like USDC and USDT, Celsius will let you buy them directly via credit card. They will charge 3.5% fee on the transaction, which is high in crypto terms. But they do offer 8.8% interest on your USDC and USDT once you have it.

Earning interest on Stablecoins means you’re not subject to the same price volatility as other crypto because these coins are pegged to the dollar. It’s just an easy to manage way to dip your toe in the water of crypto investing, but it’s not where the real money is made.

4. Crypto exchange crashes

Exchange crashes are rare but we’ve seen them happen at the most inopportune times. One very large crypto exchange went down right in the middle of a gigantic market dump in 2020 and all anyone could do was sit back and watch. Technical issues took them a couple of hours to fix but by the time the platform was up again the market meltdown had eased. It meant at the time that we were able to buy the dip on that exchange. Luckily we had other exchange accounts with some crypto in them that we could use to transact.

Here’s how to manage your risk

Keep your crypto hodl bag (the crypto you plan on holding for the long term) in a hardware wallet. If your assets are secure in your hardware wallet it means you have full control of them at all times. You can load them onto different exchanges at any time as you need to sell or swap.

Also, set up accounts on at least three different exchanges. Pick ones that are not all based in the same country (helps to manage regulatory risk). That way you have back up accounts to transact from when one exchange goes down.

We recommend that you set up separate accounts with Binance (largest volume, loads of coins), CoinsSpot (starter exchange for Australians), and Kucoin (micro and small cap coins).

5. Project collapse

When you invest on cryptocurrency you are investing in technology projects, run by teams of talented developers, cryptographers, programmers, and so on. Just like any project, crypto projects can collapse if teams implode or important personnel leave the project. Or maybe the project was based on a dumb idea, poor tokenomics or flawed code. This article from the Fool indicates more than 2000 cryptocurrencies have failed. If a project collapses, that’s usually the end of the associated coin or token.

Here’s how you manage your risk

This is a tough one to manage. You can of course keep your investments to well known projects with substantial funding and strong tokenomics. If you do want to invest in some true speculators then your risk management options are all about early exit. Keep your ear to the ground on Twitter. Follow the project and the crypto news. You’re aiming to get any adverse news about the project before it hits mainstream and tanks the price.

6. Hard forks

Many decentralised crypto projects use consensus models to govern project development. Coin or token holders can vote on key project decisions and consensus is sought. Hard forks can occur when there is no consensus on an important project decision.and the project literally forks in two different directions. Depending on their nature, hard forks can erode the value and adoption of a project’s coin or token, causing the coin’s price to decline.

Here’s how to manage your risk

Stay up to date with project developments on the project website. Understand any upcoming forks and their timing (they can take some time to play out) and make a conscious decision about whether you will divest, and when.

7. Smart contract failure or hack

Smart contracts are automated ways to handle value exchange between two parties, without involving a middleman, such as a bank. Because they are bits of code that execute in a decentralised way, they can be buggy and suffer from vulnerabilities like any other code.

According to this article from popular crypto exchange Coinbase, smart contract are susceptible to operational risk, implementation risk and even design risk. Poorly constructed smart contracts are also susceptible to theft by hacking.

One feature of the crypto ecosystem is that project teams offer bug bounties or rewards for tech savvy internet nomads to identify bugs within smart contracts so they can be fixed. Smart contracts can also be audited independently to try to identify vulnerabilities.

The real problem occurs when vulnerabilities are not identified and smart contracts with millions of dollars invested fail or are hacked.

Here’s how to manage your risk

Smart contract risk is an all or nothing deal, so the first rule is don’t put in what you can’t afford to lose. Be as safe as possible with your investment and due your own due diligence. Only put your money into smart contracts that have been audited and where the audit results have been made public. You can also get on reddit.com and see what other developers and programmers are saying about a particular protocol or smart contract. Some projects offer insurance on their smart contracts as a way to attract new investors, although insurance products like these are new to crypto and have not been put to the test.

8. Regulatory risk

Let’s face it, regulatory risk exists with every money making venture. You never quite know which direction government policy makers will pivot to next. But in crypto regulators are a quantum leap behind the 8 ball. In the US for example, government still hasn’t ruled on some of the most fundamental matters, such as whether crypto is a security or some other type of asset. This means the regulatory risk exposure is akin to highly speculative financial products. And it’s not just in the US. Around the globe there are crypto friendly governments, and some not so friendly. So how does all this present risk for your investments?

Firstly, rumours of regulatory action can cause FUD in crypto markets – Fear, Uncertainty and Doubt. FUD is market sentiment that can move the price action of a particular asset, mostly in a downward direction.

Real regulatory action can also move the market. Sometimes regulation moves the market up (if it’s crypto friendly) because having regulation in place provides certainty for investors. Sometimes regulation can cause a sell-off and move prices down if it’s perceived as punitive or as hampering development of the space

Here’s how to manage your risk

Keep up to date on crypto regulatory news from the US (as primary market) and from your home country in particular. If there is major regulatory change afoot you will hear about it on Twitter. Follow some crypto projects and personalities like Cameron Winklevoss, Michael Saylor or Mike Novogratz. Once you know about a potential regulatory change you can make your own mind up. Will it support crypto or will it hamper growth? This knowledge will help determine what you do with your investment.

9. Human error

This one goes hand in hand with the non-custodial nature of cryptocurrency. If you lose the private key you need to transact your crypto assets, you will need to have your recovery seed phrase at hand. If you have a particularly human moment and lose your seed recovery phrase, you’re done. That’s it. Drop the mic – your crypto is gone.

Here’s how to manage your risk

This one’s simple – do not lose your seed phrase!. Here’s how to go about it…

Keep your crypto secured with a hardware wallet.

Get a metal crypto wallet for the recovery phrase that backs up your hardware wallet.

If you don’t have a hardware wallet or metal seed storage wallet then you’re exposing yourself to cyber hack. We recommend this site – cryptowalletreviewer.com to find the best hardware and metal crypto wallet. We personally have the Ledger Nano X and the Billfodl metal wallet to keep our crypto safe.

Treat both your hardware wallet and your metal seed phrase wallet as though they are little bars of pure gold. Store them securely in different locations (never together).

10. Market manipulation

Ever heard of crypto whales? Whales are large holders of particular assets, for example Bitcoin whales or Chainlink whales. Whales can and routinely do use their large holdings to manipulate price action in crypto markets. So how do they go about it?

Whales can place very large sell orders at a price below other sell positions in the market creating volatility following which prices can fall. The falling price can then cause a chain reaction as stop losses set by other traders are triggered. 

That’s just one example of how whales might use their coin bags to manipulate price in the crypto market.

Here’s how to manage your risk

Cryptocurrency blockchains are publicly viewable which means if you know how to read the data you can work out whether ownership of the coin is concentrated in the hands of the few. Coins with concentrated ownership are ripe for the picking by manipulative whales.If you don’t want to go through the laborious task of doing this analysis yourself or are not technically inclined, you can use Glassnode or CryptoQuant – blockchain analytics services.

Or you can do absolutely nothing – accept this risk as a part of crypto price volatility and move on. That’s what we do, along with not putting too much of our money into a single crypto asset.

Diversification in crypto is a foundational risk management approach – use it! Diversify across assets, across DeFi protocols, across exchanges, and platforms. Divvy up your investments into smaller bags that you could afford to lose if something goes wrong.

11. Theft or hack

There are two types of theft you need to manage risk for in crypto

1. Cyber theft or hack – just as it sounds, this is the theft of your crypto on the internet. It can happen to your directly – where coins are stolen from your online wallet – or through a third party like a crypto exchange or DeFi protocol. Exchanges and protocols are hacked regularly, with the latest being a $600 million white hat hack of PolyNetwork.
2. Physical theft – you might be wondering how physical theft can occur in crypto if your coins are non-physical objects. Ever heard of the “$5 wrench attack”? It’s basically where someone steals your hardware wallet and with it the private keys to your cryptocurrency.

Here’s how to manage your risk

• Good cyber hygiene –
  • keep your apps and operating systems up to date always.
  • Use a password service like LastPass to manage your passwords.
  • Make sure you have unique passwords on your home WiFi and modum.
  • Use 2 factor authentication on websites and apps associated with crypto.

• Use hardware wallets and metal crypto wallets – you don’t have full control over your coins if they are on an exchange. The best way to avoid theft via an exchange or protocol is to transfer your coins to a hardware wallet. If anything happens to your hardware wallet you can recover your coins with the wallet’s recovery seed phrase. This is why you also need a metal crypto wallet as well as a hardware wallet. A metal crypto wallet is an indestructible and secure place to store the recovery phrase for your hardware wallet in case you need to restore your crypto nest egg.

• Proper physical custodianship of your hardware wallet and metal crypto wallet – keep them secure and apart. If one is stolen with the other your coins are gone and unrecoverable.

12. Scams

Scams in crypto are rife and understandably this is very off-putting to new investors. According to the US Federal Trade Commission, the most common crypto scams are:

• Giveaway scams – members of particular online crypto communities get free coins if by send their coins to a posted wallet address
• Bogus websites – with scam investment opportunities offering block buster returns using fake testimonials
• Impersonators – Elon Musk impersonators have duped unsuspecting coin holders out of $2 million collectively
• Online dating apps – used to lure people into cryptocurrency investments (yeah I know I can’t believe it either…)

Here’s how to manage your risk

Scams are a problem that you can overcome by knowing what you’re investing in and by doing your own due diligence. If you come into crypto understanding that it’s designed to be decentralised and non-custodial, you’ll appreciate that you alone are responsible for the security of your assets. If you get this, you’ll do your own due diligence and only invest in crypto with demonstrated real world use cases. You’ll accept that investing in anything else is either highly speculative or you’re at risk of being scammed.

Here are some tips to avoid getting scammed if you’re new to crypto investing:

• NEVER send your crypto to wallet addresses sent to you in unsolicited emails, social media, group chat apps like Telegram and WhatsApp.
• If you come across an ‘investment opportunity’ that seems too good to be true then it just is.
• Don’t respond to unsolicited offers. If someone reaches out to you to join a crypto community or promote a killer crypto investment opportunity over social media, via email, in Youtube comments or in any message group forums it is likely a scam.
• Make sure you have the genuine website or app. Fake websites, apps, groups or project profiles are a big issue in crypto. Type the web address in every time and don’t use autofill. Link to the project app directly from the developers website and don’t search it on Google Play or The App Store.

13. Rug pulls

A ‘rug pull’ is a phenomenon specific to decentralised finance (DeFi). A DeFi rug pull is when a team of developers disappear with all of the liquidity added by users to a particular DeFi Protocol liquidity pool. If you want to know more about DeFi lending and liquidity pools (and how to make money from them) check out our How to Invest in DeFi post.

How to manage your risk

1. Avoid new DeFi projects – early projects is where the serious money is made, but it’s also where authenticity and legitimacy are questionable. At a minimum avoid low initial liquidity projects. Just like in the fiat world, scammers find it tough to raise large bags of initial capital for new projects.
2. Make sure there is a project whitepaper and read it. Compare it to other legitimate white papers.
3. Watch out for social media campaigns on tokens with claims of benefits that are too good to be true. Fake hype on Telegram and Twitter is a telltale sign.
4. Research the project – is the developer team transparent and known in the crypto community? If not, do you really want to trust them with your assets?
5. Get on to Reddit and research the token and the project and any red flags raised by other developers.
6. Check that there is an audit of the protocol by an independent know auditor. Audits are expensive and having one helps legitimise the project.
7. If you are more technically savvy, check the smart contract history on Etherscan or Polygonscan.
8. Watch the token price. If the price starts to tank, get your coins out immediately. Offload the scam token and get your valuable tokens back in to your hardware wallet!

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