What's cryptocurrency?
The cryptocurrency word can be divided into two parts: crypto, which means hidden, and currency, which is a medium for exchange. It is a virtual or digital currency that is secure thanks to encryption (Blockchain technology). It is independent of any software or institute and aims to create an alternative financial system. It can do unlimited transactions and has unlimited volume. Its purpose is to replace paper currency and to be used as an investment. It is also known as digital gold.
It is created by strong cryptography across various computer networks. Blockchain is the basis of cryptocurrency. Cryptocurrency has a decentralized nature and is a decentralized exchange. It is not controlled by any central authority or regulatory framework. It is free from regulation and interference. Bitcoin, the first cryptocurrency, was launched in 2009. Today, more than a thousand currencies trade on this platform. Bitcoin is the most well-known cryptocurrency, and it has been around for quite some period of time. Etherium, Dogecoin, etc. There are many other crypto currencies.
Why are cryptocurrency trends?
Recently, cryptocurrency has been one of the most talked about topics on the internet. Even though they don't know the exact meaning, most people who use the internet have heard of the terms 'cryptocurrency 'or 'bitcoin '. Every other internet influencer is talking about crypto and promoting its applications. What's the buzz about crypto? There are many reasons why this buzz exists. Let's take a look at each one. Since there are no laws governing cryptocurrency in India, it is not criminal either. A tax is levied in India on cryptocurrency purchases. There are many websites and apps that allow you to trade cryptocurrencies. These sites and apps are promoted digitally and through influencer marketing.
Many cryptocurrency traders offer cryptocurrency education through their courses and on YouTube, which again draws in internet users. The legalization of bitcoin and cryptocurrency is a debate that will never end. While many countries have already banned cryptocurrency, the US is working to regulate it. As the big business tycoons and profit-& loss-makers from different countries talk about it, more hype is created.
These are just a few reasons why cryptocurrency is so popular. Bitcoin might not be the next great thing, but there is one thing for sure: if you don't consider the danger, you will eventually collapse. While there will be many card channels that talk about why you should invest in crypto, very few people discuss the risks associated with it. Be aware of the market risks and make the best decision for yourself. Mining is difficult because of increased competition. It is also dynamic so mining will always be profitable so long as Bitcoin stays more fungible than digital fiat. Speculative investments are what cryptocurrencies are often called. In other words, the current prices of most popular currencies have become more volatile over the last few months.
What Risks are Associated with Cryptocurrency?
Highly Volatile: The volatility of the crypto market has been extremely high. Extremely high price swings are a result. The volatility and fluctuations can't be explained accurately. People are reluctant to invest in cryptocurrency because of its unstable nature.
Impossible Transactions:Transactions take just a few minutes. Once the cryptocurrency transaction has been completed, it can't be reversed unless the other party is willing to do so. Because the identities of the other person are not revealed, there is a high risk of irreversibility.
Unregulated: Cryptocurrency cannot be backed or backed by any government financial institution. Financial markets are safer because they have been backed and monitored by an authority that continuously strives to protect investor safety.
Cyber Frauds and Hacking: Cyber frauds and hacking are very common in Cryptocurrency and have attracted the attention of scammers and hackers. Despite crypto trading being strongly encrypted, hackers can still find ways to commit frauds. However, one can mitigate this vulnerability with enterprise risk management.
What Can You Do To Mitigate This Risk?
1. Learn about Important Crypto Coins
Before you invest in any cryptocurrency, make sure to research it thoroughly and gather investment advice. It is not a good idea to invest just because you feel like it, or without consulting an investment advisor.
2. Know Your Reward/Risk Ratio
The reward to risk ratio (or return to profit ratio) is the amount you can expect to make for each unit of currency that you risk. Only invest what you are willing to risk.
3. Diversify Your Portfolio
Investing in multiple crypto coins can help reduce potential risk. Diversifying your portfolio reduces risk. The impact of volatility can also be minimized because investment is made across multiple coins. Some coins are highly fluctuating, while others are stable.
4. Identify Your Entry-Exit Strategy
Both your entries and exits are essential to your crypto traders. While a great entry is the cherry on top of a profitable trade you should also consider exits. You must not only take into account gains but also losses. A solid risk management strategy includes planning for exit points. Risk managers often look at similarities between cryptocurrencies and financial assets when addressing the question of how to best manage cryptocurrency risk. Risk managers need to be aware of at least seven unique challenges that cryptocurrencies present.
5. Diversit
First, risk managers must recognize that crypto Asset can be qualitatively different and not interchangeable. There are many dimensions to the bewildering variety of cryptocurrency, including security, programmability, and governance characteristics. Simply put, there is no cryptocurrency that is "cheapest to deliver.". When assessing, managing, and monitoring risk, it is important to consider the differences between cryptocurrencies' features. BTC is the original cryptocurrency. It's a simple concept. It is designed to transmit, receive, and store value in a digital and cryptographic format. This includes functions that are similar to money and gold.
The primary functionality of BTC is expanded upon by ETH, the second largest cryptocurrency exchange, by adding more intricate, self-executing smart contract features that may digitally mimic complicated financial instruments and transaction fees. ETH can also be used to create new cryptocurrency exchange software.
Stablecoins and other cryptocurrencies add to the complexity. Their value is linked to fiat currency (such USD). These digital assets allow for a fixed crypto exchange of value, essentially by exchanging national currencies into unstable cryptocurrencies. The specifics of the governance and issuance of cryptocurrency can further complicate the landscape. Transaction tracking and validation responsibilities, for example, are split between users and cryptocurrency issuers.
6. Valuation Difficulties
One of the most important steps in managing the financial risk associated with any financial instrument is to determine and quantify its exposure using derivatives market-wide methods. Cryptocurrencies are special, though, in that there is no accepted technique for valuing them, there are no standard measurements, and the stated pricing data can vary between sites. Risk managers must be aware of the many different valuation methods that are used to determine the value of cryptocurrencies.
Analysts approach the valuation problem from a functional perspective, treating cryptocurrencies like currency in circulation or fiat money like USD or EUR. This approach is based on a flawed assumption and ignores fundamental factors differences between cryptocurrency and traditional financial instruments. In particular, cryptocurrencies do not qualify as legal tender and are not subject to legal safeguards. They also lack explicit or implicit government backing. Therefore, they cannot be legally used to settle final transaction status.
Calculating the addressable market (or current market capitalization) for each cryptocurrency is the most popular way to value them. This method falls short of capturing the potential and real value that cryptocurrencies may offer depending on how they are applied.
Analysts take this approach and value cryptocurrencies using a network perspective. This involves estimating the possible users and forecasting the likely usage scenarios based on governance or programmability structures. This valuation approach, which is both model-driven and assumption-driven, may not be able to withstand high scrutiny but it does provide an additional level understanding of the potential exposures and risk levels for cryptocurrencies.
Others, especially institutional analysts, value these asset classes based on the electricity consumed to create, store, and verify each cryptocurrency. These valuation results are comparable and take into account the underlying and defining characteristics of each cryptocurrency. However, they may be affected by differences in electricity costs between major mining centers.
7. Legal and Regulatory Dilemmas
Contrary to financial instruments, cryptocurrencies do not have the same legal protection and financial advice as traded financial instruments. This creates complex legal risks and introduces uncertainty that can have a significant impact on both the investability and risk management of these digital assets.
There is no consensus internationally on how best to regulate cryptocurrency, especially in relation to product development and trading. The inconsistent and sometimes even erratic government stances have led to inconsistent results. While some countries prohibit the creation, sale, ownership, and swing trading of certain cryptocurrencies, others allow and encourage their proliferation.
Other countries are creating forward-looking, wide-ranging regulatory standards for issuance and trading, reporting, transparency, and reporting. Because these requirements are typically only valid inside a single jurisdiction, governments unintentionally create islands with minimal legal protection in a sea of uncontrolled bitcoin.
This basic legal protection allows many to explore the potential of cryptocurrency; however, for others, the absence of uniform regulation perpetuates legal, compliance, and regulatory obstacles that prevent the development of these asset classes. Risk managers should be aware of the fact that transaction history in cryptocurrency markets can present unique legacy market and compliance risks.
8. Data and Modeling Challenges
The data necessary to model future cryptocurrency risks and exposures may not be available to risk managers. One's capacity to estimate the variables influencing bitcoin risk and returns and to compute essential measurement metrics, such as stress testing, VaR, and ES, may be constrained by insufficient transaction data.
The volatility of cryptocurrencies is high and they are easily traded around the world 24 hours a day. It is difficult to model the cryptocurrency fair market's detailed, but limited data set of transaction fees because it does not provide enough detail. In fact, predicting the current market price, return, and equilibrium-generation function of cryptocurrencies is essentially a guessing game because there is no general agreement on these issues.
Many risk managers model cryptocurrency exposures using statistical techniques like spectral decay to find variables that can be utilized to enhance pricing, risk, and trading models. These modeled prices, especially for stress testing purposes, are not realistic and therefore, their utility is questionable.
9. Illiquidity and Trading Expenses
The cryptocurrency market is typically less liquid than traditional markets and therefore more expensive. Many cryptocurrencies have a controlled supply, with new units being released according to a predetermined time frames. It should not be surprising that cryptocurrency prices are volatile.
The cryptocurrency markets will struggle with low liquidity and high volatility. This will make price discovery difficult. Gapping is a continuing problem in these bear markets and restricts investors' ability to exit their cryptocurrency positions. The growing body of evidence suggesting that some exchanges manipulate pricing, engage in customer fraud, and front-run huge trades only serves to complicate matters further.
There is no uniformity in the way cryptocurrency trading is treated. Some exchanges include the inherent characteristics of cryptocurrency investment, while others allow bilateral trading. Others replicate the core features of online trading platforms. Risk managers need to be familiar with the details of each approach to trading venue.
Read More: Amazing Facts an Investor Should Know Before Investing in Cryptocurrency 2023
10. Clearance, Custody and Settlement Issues
Institutional interest in cryptocurrency depends on the availability of prime brokerage services and institutional-grade custody solutions. Fintechs and specialized financial institutions offer highly customized solutions, which range from simple digital wallets to complex functionalities that are designed to satisfy institutional investors. Institutional custodial solutions for cryptocurrencies are complicated from a legal and technical indicator. The complexity of cryptographic transactions is partly due to the use of both public-key and private-key encryption.
These cryptographic keys are easily accessible and public so they must be protected. Multi Layered security features must be included in custodial solutions to ensure that these keys can only be accessed, used and verified by custodial systems. Neglecting to implement security measures can lead to disastrous consequences. Many cybertheft incidents, such as the destruction of Mt. Gox (bitcoin exchange) were the result of poorly designed security features that made it possible to gain access to cryptographic keys.
This is complicated because there is no standard for clearing and settlement cryptocurrency transactions. This exposes traders to substantial counter party credit card risk. Payments made using cryptocurrencies settle instantly when the system authenticates the transaction. Authentication can occur immediately or with a limited time frames. The final settlement of cryptocurrency trading fees depends on the characteristics of the cryptocurrency and the centralized exchange where the transaction took place.
Additionally, cryptocurrencies cannot be used legally to settle trades involving them. How exposures are valued and managed can be affected by the actual cost of exchanging cryptocurrency for fiat money. Consider this scenario: A BTC for ETH exchange must be settled in USD. For this, BTC must be converted to USD and then to ETH. Such a transaction has a cost associated with each leg.
The unique relationships between players will determine how the mechanics work and the risks. Asynchronous settlement of cryptocurrency trades presents a significant problem. This is especially true because the logistics and mechanics differ greatly between exchanges and even among users of the same custodial and digital wallets. This complicates the assessment of the underlying risks and increases the severity of counterparty credit risk. In this "challenge" category, corruption is the final consideration. Many schemes for money-laundering have utilized cryptocurrencies. This is a result of both poor custodial standards and dishonest custodial solutions. You must be vigilant for these types of criminal activities.
11. The Risk of Cryptocurrency Derivatives is High
Investors and traders continue to be attracted to cryptocurrency futures trading. These cryptocurrency derivatives, however, are not like derivatives on commodities or financial instruments. They are used to increase exposure rather than reduce risk. By design, contracts-for-differences, also known as exchange-the-difference contracts, are frequently used to describe bitcoin derivatives that are available for trading.. CFDs, which are cash-settled contracts between investors, brokers, and based on the value of the underlying (e.g. cryptocurrency) asset classes, are used by investors to place limit price bets about the future price of that asset.
Surprisingly, neither local nor foreign platforms allow U.S. citizens to register CFD accounts, according to the Securities and Exchange Commission and the Commodities Futures Trading Commission. Dodgy market participants may take advantage of the lack of awareness about the differences between different types of crypto derivatives. They may even encourage fraudulent investments and instruments. These hazards must be managed by risk managers, who do not have the benefit of traditional derivatives trading.
The Best Ways To Manage Risks and Money When Trading Crypto Futures
1. Trading Plan
Every serious trader should have a trading plan. A trading plan is essential, especially in volatile crypto markets. It can help you manage risk better. Trading plans can help improve your trading consistency, and ultimately allow you to scale up to profitability. A trading plan must be detailed. It should include information about how you will enter and exit positions. This includes position-sizing and entry indicators. A trading strategy has many benefits. They can help you make better decisions and take trading seriously.
After you have established a strategy, it is important to follow the strategy even if you lose trades. Trading is a game that involves losses. Even the most experienced traders will experience them. We often see traders lose trades and abandon their trading plans. To build a solid long-term trading record, it is important to stick with your strategy. If you panic or abandon your plan, you are likely to make more trades that are not on-track. Worse, in your fury to regain lost trades, you might even lose more.
2. Stop-Loss Orders
Risk management is about reducing the risk of large losses. One common way to minimize losses is to use a stop-loss. An order called a stop-loss allows investors to limit their potential loss by limiting the price at which an asset can move.
Let's say you buy 10 BNB beacon chain contracts at around $350 each. You could also place a stop-loss or order at 20% lower than the purchase price (around $280) to minimize any loss. Stop-loss orders are used by investors to exit their positions if they fail to perform as expected. Investors can use stop-loss orders to avoid letting emotions affect their investment decisions.
3. Money Management: Never risk more than 5% per trade
Money management allows you to adjust your position size to minimize risk and maximize the potential growth of your trading account. This strategy limits the amount of capital that can be placed on any trade to 5% or less. While the dollar value of the 5% fluctuates with account values, the 5% limit will ensure that your account is not too exposed to just one position. It is possible to lose all of your investment capital within minutes due to the volatility and unpredictability of cryptocurrency. Investors should be more careful when trading volatile assets. The rule of thumb is to only risk 1-2% of your capital for any given trade.
As an example, let's say you have 10,000 USD in your USDS M Futures wallet. This would mean that you would be able to allocate 100-200 USD of risk per trade. You would lose only 1-2% of your capital losses if a trade goes wrong. Management of your risk requires you to have the right size positions, know how to place stop losses and take into consideration the risk/return ratio. You can build a portfolio you will not lose sleep over with a solid money management plan.
4. Don't Over-Trade
Anyone who trades in futures or as an investor must ensure that they do not overtrade. Overtrading is when there are too many positions open or you risk losing a lot of capital. This can expose your entire portfolio to unnecessary risk. Over-trading can be avoided by following a trading plan.
New traders are known for their tendency to over-trade. This is often due to their inability to control emotions like fear, greed, and excitement. Although traders can make huge profits by opening multiple positions, losses can be just as devastating. To limit losses from all your positions, it is prudent to set a maximum amount of capital that you are willing to risk.
For example, if you have 25 positions in a portfolio and the risk per position is 1%, it is possible (and almost everything can happen in crypto markets) that all 25 positions could be against you simultaneously and cause a significant loss of 25% to your portfolio.
You should consider more than just the risk of each trade. Also, take into account the cumulative risk in your entire portfolio. This is known as the total capital risk. Your total capital at risk should not exceed 10% of your portfolio. This means that if you are exposing 1% of your portfolio to risk per trade, there should be no more than 10.
5. Avoid making larger investments than you can afford to lose
One golden rule about investing is to never invest money you cannot afford to lose. One characteristic of crypto futures is volatility. It is easy to lose money in market volatility. Prices can fluctuate rapidly at any moment. To avoid emotions from influencing your investment decisions, you should not trade crypto futures without sufficient savings.
Good traders must be able to control their emotions and work in a calculated and systematic manner. To protect your capital, you must also have a solid risk- and money-management strategy. Keep in mind the rule of thumb that you should only risk 1-2% of your account balance per trade. Also, be prepared to lose losses if necessary to accept them as part futures trading.
Conclusion
Futures trading can be very profitable due to the high leverage. However, if one does not have a good understanding of the system and how to control cryptocurrency risks, they could lose all their investment. If you want to earn higher profits and take on more risk, crypto futures can be a great investment option. You can maximize your returns and minimize losses by managing risk and investing in crypto futures.
