Although investing in cryptocurrencies is indeed one of the most important decisions that your foundation can make at this point in time, it helps to know how to make the right investments and how to manage the risk that you hold in those investments.
There are a number of ways in which you can reduce the risk in the investments that you hold. They range from the traditional down to the more unorthodox. What is however essential is to know what you want from your holdings and how you plan to achieve it.
It is also worth pointing out just how volatile cryptocurrencies are. This is indeed something that many people know. You need to make sure that no matter what volatility comes your way, the portfolio is not too exposed to one coin or risk.
Diversification is Key
It is one of the most tried and tested ways to limit your risk to one particular asset. The notion that you should never have all your eggs in one basket has been around for a number of years and will indeed persist.
When it comes to investing in cryptocurrency, this is exactly the same. If you place all of your investments in one crypto asset, you run the risk and exposure to that only. Hence, it helps to have a bit of diversification.
However, diversification can also be a double edged sword. If you have too many “baskets” then indeed you do run the risk that you returns in one coin are eliminated by poor performance in the other. It is very important that you do not dilute your returns.
We would suggest holding your tokens in the top 5 Cryptocurrencies in a roughly equal proportion. This means that you are getting exposure to the most important cryptos but not unnecessarily diluting your profits but have enough diversification to protect you from large falls in one cryptocurrency over the other.
Hedging with Options
In traditional finance such as Investment Banks and Hedge Funds, they can use derivative tools that allow the trader t hedge exposure to downside falls in the asset. Some of the most effective of these are financial options.
These are asymmetric investment instruments that allow the trader to only hedge one side of their trade. They confer the holder the right but not the obligation to execute the trade on expiry. In the case of a long position in a cryptocurrency asset, you would want to hold a PUT option on the underlying asset.
Hence, in the case of a fall in the price of the asset, you will gain on the downside with the option. This is because a PUT option will increase in value when the price of an asset decreases. You can see the image below that has a sample PUT option and the underlying option payoff.
If you wanted to implement this strategy then you would need to find a legitimate option broker to use that is fully regulated in a jurisdiction that you trust. There are a number of cryptocurrency option brokers that you can use. It is important that you make sure they have the assets that you would like to trade there.
Of course, options are great because they only have to be put on at a period when you think that there will be considerable volatility. This is usually during times of when potential news about a coin could come out. It could also be as a result of a planned upgrade on the network.
For example, there was a lot of volatility in Bitcoin prior to the hardfork that happened in August and again recently when Bitcoin gold split. We are also seeing it in periods now before the anticipated SegWit2X hardfork in November.
Hence, just prior to these announcements you can place a trade and enter a PUT option if you fear the potential fall in the price of Bitcoin after the Fork. This would allow you to lock in your gains on Bitcoin, grab your new forked coin and profit from it.
Due Diligence on ICOs
This of course goes without saying. ICOs pose a risk because you are taking a bet on some future project that has not really got a running business. You are placing funds in an entity hoping that the idea will be enough for you to make money.
Hence, you will want to make sure that you understand everything that the project is promising. You need to read the white paper completely and make sure that you fully understand the technical details of the project. Due diligence with ICOs is key.
Some of the ICOs that are being presented in today’s day and age look like nothing more than a pyramid scheme that will make money merely by issuing new tokens to pay out those that invested earlier.
Don’t Get Carried Away
Of course, a lot of the risk mitigation that you can do in cryptocurrency is mere logical thinking. Don’t invest more than you are comfortable on any one project or coin. Don’t buy into hype and take “people’s word”. Take a look at cold and calculated numbers to inform your opinion.
It also helps to make sure that the holdings that you have make sense compared to the investments of a number of other foundations and charities. You can reach out to your advisors and workers at IJP and contact us for advice on the most sensible cryptocurrency investment choices. Our extensive client list is updated with regular holdings and we can give you the best information.