In a previous post, we described the benefits of using very simple risk metrics to improve the return of your investment strategy. In the following the general risk are described. Thé objective is to guarantee investors of smart investments.

Cryptocurrencies face a wide variety of risk:

• Market risk

• Liquidity & Exchange risks

• Operational risk & Fraud risks

• Legal & Governmental risks

• Value risk

• Etc.

Risks

Looking at the list may start to be frightening. Market risk is simply the price change over the day, related to transactions. One can tackle this risk by:

• Diversifying the portfolio of cryptocurrencies with assets that have negative correlation

• Buy hedging tools such as futures

In practice however, most cryptocurrencies are correlated and deem to follow more or less the bitcoin variations. Hence it is hard as of today to use any relevant approach. Futures are bitcoin specific.

Liquidity risk represents the effect of a transaction on the global price of the underlying asset. It is particularly high with cryptocurrencies. ICO dates present substantial liquidity risk. The token cannot be exchanged unless the project starts and delivers something. Trading platforms do not accept alt-coins except mainstream cryptocurrencies. Hence, it is a very risky bet. Nothing can prevent investors from it, unless the currency has already a wide community to cool it down.

Exchange risk is simply the risk for not finding a buyer assuming an investor wants to make profit out of its investment. Assuming the price has increased significantly, it does not mean there are buyers.

Broadly speaking, operational risk is any risk of loss due to a failure in the normal operations, related to humans or technology. It is very high with cryptocurrencies. Theft occur on trading platforms. A single typo on the address where the money is supposed to be sent and the money is lost forever. There is no roll back possibility. There is no market mechanism that prevents a single buyer to sell everything at once, hence significantly disturbing the market. Fraud is highly unlikely on the protocol side, yet applications are all too frequently attacked. In other words, very risky.

Governmental risk is very theoretical in finance classes. With cryptos, it is bread and butter. When China and Korea ban cryptocurrency transactions and ICOs, the effect is immediate. Minus 50% on the crypto-markets, altogether. A single law can significantly alter the outcome of a funding campaign or a cryptocurrency behavior. Tax laws on the cryptos may create what can be dubbed as crypto-tourism, where investors hold accounts in tax friendly countries, e.g., Switzerland.

Value risk is the risk for a given asset to be valueless. We are used to market risk with conventional finance and investment tools. Much less to value risk. In practice, a currency is backed by a reserve of gold in central banks. A cryptocurrency is simply a sequence of bits on an address on a network. It is not backed. It can be valueless in the glimpse of an eye, much like shares before the 29’ stock market crash.

Outsmart risks

To summarize, a cryptocurrency is very risky. Much of its properties are shared with hedge funds. Therefore, professionals start to flood in and invest massive amounts of cash so as to generate money. Do not be fooled. As soon as crypto gain in legal interest, a really massive amount of money will arrive. We have started to see it coming with half billion-fund raised in a single IPO over last year.

Hence, be smart, and do not forget the risks associated with the project you invest in. The true value lies in the skills and vision of the project team. Invest in Neurochain.

Photo Credit: Splitshire