Cryptocurrency investment has grown substantially over the last five years, with 14% of Americans now holding digital assets in their portfolios, up from a reported 1% in 2016. Some industry leaders have predicted this figure could double by the end of 2021, after 13% of survey participants expressed intentions to purchase crypto over the next few months.
For many new investors joining the market, learning how to get the most out of your crypto assets is essential for reducing risk and maximizing any potential returns. Here are four useful tips to get you started.
One of the easiest ways to reduce risk and, in some cases, help improve returns is by investing across a range of different crypto assets. This is known in the trading world as diversification, or asset allocation. The idea behind this is to spread your investments to average out losses if the market takes a downturn.
For example, Bob and Alice both invest $1,000 in cryptocurrencies. Bob decides to invest $100 across 10 different cryptocurrencies, while Alice decides to go all in on a single asset. Alice is running the risk that if the market turns bearish, and if the project she invested in takes a heavy hit, she could suffer heavy losses. Bob, on the other hand, has spread his risk and stands a better chance of losing less overall (depending on whether he’s invested wisely or not). This can also work when the market rises.
A common strategy is to select different types of cryptocurrencies to ensure you benefit when one of the many sectors experiences a surge. Conversely, it also spreads risk in case there’s a dip in one or multiple sectors.
Here are just a handful of examples of different cryptocurrency types:
- Store of value: bitcoin (BTC)
- Non-fungible tokens, or NFTs: CryptoPunks
- Smart contract technology: ether (ETH)
- DeFi: uniswap (UNI)
- Payment coins: litecoin (LTC)
- Privacy coins: monero (XMR)
It is worth noting that although diversification aims to reduce risk or loss, it also has the potential to reduce your return on investment.
2. Copy trading
The setup is simple:
- Select a trader to follow based on factors such as previous performance, number of followers and overall risk score (how risky are the invested assets).
- Link your account to their movements.
- When they choose to buy or sell a crypto asset, your portfolio automatically does the same.
This is a completely hands-free way to trade cryptocurrency without needing to study and track the market yourself.
Once you have settled on a trader (or traders), you can determine how much of your portfolio to allocate to each trader. Typically, this is in the form of a percentage of your balance. So if you have a balance of $1,000 to be invested, you could allocate 10% of your portfolio to copy trade one trader and 10% to another. This is another example of diversification and helps to spread out your funds and build a balanced portfolio. After you have finalized your investments, the trades will automatically start happening. Of course, you can always change traders or add more funds if they are doing well.
Just because they’re professional traders doesn’t mean they get it right every time. You cannot predict the success of a trader or the future movements of crypto assets so it is crucial to set up a loss limit. This is an automatic order that automatically stops your copy trading if you lose a predetermined amount or the value of an asset drops.
3. DeFi staking
This is where things start to get a bit more technical.
DeFi staking is a way of locking up your crypto assets in special, autonomous platforms known as “decentralized applications” in order to receive annual interest.
DeFi – or decentralized finance – is a sector of the cryptocurrency industry that takes traditional financial services like loans and insurance and puts them on the blockchain. The main difference being, the decentralized financial applications these services run on are not controlled or maintained by any single company. Instead, they are managed completely by their own communities of users and through automatically executing computer programs known as “smart contracts.”
DeFi staking is a great way of generating an annual return on your deposited assets if you only plan on buying cryptocurrencies and holding them. The process is similar in nature to depositing money into a savings bank account except instead of earning less than 1% interest, you can typically earn anywhere between 5%-25% and in some cases, higher.
- DeFi platforms are not regulated. This means there are no consumer protections in place in the event you lose your capital from theft or fraud.
- A number of DeFi platforms have not had their computer code audited by a third party to ensure there aren’t any bugs or exploitable flaws. This leaves the platforms vulnerable to hacks and exploits. So far in 2021, $361 million has already been stolen from DeFi applications.
It’s recommended anyone looking to lock away funds in a DeFi staking application should perform his or her own rigorous due diligence beforehand.
4. Learn to hedge crypto trades
What is hedging?
Hedging is a type of investment strategy aimed at reducing potential risk and losses incurred during adverse price movements in the market. It involves placing a primary trade in the direction you expect the market to go and then placing a second trade in the opposite direction. The idea here is, if the market goes against you the second backup trade you’ve placed will be in profit and offset the losses of your first trade.
A popular way crypto investors hedge their trades is by going long or short in the futures market. This is where two parties agree to trade a specific asset at a predetermined price and date.
- Going long: Where you think the price of an asset will rise so you agree to purchase it at today’s price at a predetermined time in the future.
- Going short: Where you think the price of an asset will fall so you agree to sell it at today’s price at a predetermined time in the future.
It’s important to know that trading futures is highly risky and should not be attempted by inexperienced traders. While it has unlimited upside potential (meaning there’s no cap on how much you can make), it also has unlimited downside potential. This means in some instances you can end up having to owe an exchange more than you initially invested. Stop-loss orders are advised to reduce risk when trading any asset. These automatically exit you out of a trade when the market price reaches a predetermined level.
Why would you hedge your crypto investments?
The crypto market is renowned for being highly volatile. This means the price of cryptocurrencies can change dramatically over a defined period of time. Bitcoin, for example, rose 125% between Jan. 1 to April 15, 2021, only to fall by 54% a few months later. Since the dip, prices are now up around 59%.
This unpredictability makes it incredibly difficult to know which direction the market will turn at any moment, meaning there’s a good chance the crypto assets you invest in won’t always go the way you want them to. Hedging provides peace of mind that whichever way the markets move, any losses suffered won’t be as severe.
The cryptocurrency space is constantly adapting and growing, providing ample opportunity to maximize your investments. These strategies are just a handful of ways to successfully stretch your funds and give you the greatest potential for a high return on investment based on the level of risk you are willing to tolerate. But it is also key to remember the golden rule for investing: If you are worried about the risk to your position, closing it or reducing its size is a safer option. And remember: Always invest and trade an amount you can afford to lose.
This content is for informational purposes only and should not be construed as investment advice. Nothing mentioned in this article constitutes any type of solicitation, recommendation, offer or endorsement to buy and sell any crypto asset. Trading in any financial market involves risk and can result in loss of funds. Before investing any money, one should always conduct thorough research and seek professional advice.