Crypto has disrupted countless sectors, such as banking, with digital currencies experiencing significant gains over the past decade. However, the prices of cryptocurrencies, such as bitcoin and ether, have also seen extreme price volatility, which has called into question the very viability of crypto as an asset. For those who want to ride the crypto wave, here are some ways to reduce the risks of investing in digital currency.
Do your research
Before investing, it is important to conduct plenty of research, such as discovering what are the most popular cryptocurrencies, why they are attractive to investors, and potential risk factors.
Relying on past price data can be misleading given the rapid rise of crypto. For example, bitcoin was at $0.09 when it launched in 2010. In the intervening years, its value reached $60,000 in 2021 before it declined significantly. However, investors can educate themselves on the issues and potential challenges facing individual cryptocurrencies and the market as a whole, as well as potential future developments.
Key areas to consider include how jurisdictions plan to regulate crypto and the effect of the wider economic outlook. One thing to avoid when investing is getting swept up in market hype, which is a feature of crypto.
Given the price volatility of crypto, more experienced investors might consider hedging. This means making a primary investment with an expectation the market will go in one way, and a secondary bet it will go in the other. The idea is to partly offset any losses by having a stake in both outcomes.
Investors who take a long position agree to purchase a cryptocurrency at its current price on a specified future date, expecting its price to rise. Using bitcoin as an example, an investor paying a 2010 price for 2021-value bitcoin would have made considerable profit. On the other side, a short position means an investor agrees to sell a cryptocurrency at its current price on a future date, “betting” its value will fall.
For example, an investor who agreed to sell bitcoin at its 2021 peak of $60,000+ would have seen that hedge pay off if they sold in mid-December 2021, when it was back down to the mid-$40,000s.
Invest via companies or index funds
For investors cautious about investing directly in a cryptocurrency, two ways to mitigate the risk are to invest in companies which have holdings in crypto or to invest in crypto-orientated index funds.
Investing in a company that holds crypto offers some protection against price fluctuations in digital currencies. Further advantages of this strategy include enjoying the stock price boost if the cryptocurrency holdings rise, plus the expertise of the company’s investment team, which hopefully makes smart decisions about the firm’s holdings.
Investors can check a company’s financial data to learn how much crypto it holds. Meanwhile, investing in an index fund offers exposure to a range of cryptocurrencies, usually based on their market capitalization.
Cryptocurrencies come with inherent price volatility, which means risk for investors, as they try to predict whether the price will gather momentum or continue to fall. Of course, the upside of this is the potentially large returns for investors who do their research and employ a solid investment strategy. However, investing in crypto is not for the faint-hearted.