At the onset of a crypto winter, financial advisors can keep their clients engaged with bitcoin (BTC) but help them remain safe at the same time.
That winter is now upon us and a flurry of failures, bankruptcies and collapses has already occurred – with possibly more to follow.
I think these issues come in two different varieties – yetis and avalanches. Yetis are the bad actors who could steal crypto assets or who design projects in a haphazard manner. Avalanches are the collapses that leave the end investor holding the bag.
Look no further than the avalanche last week caused by the failure of crypto hedge fund Three Arrows Capital: Voyager Digital declared bankruptcy, leaving clients of the exchange potentially unable to recoup any investments stored there.
As advisors, the goal is not just to keep clients calm throughout price volatility of cryptocurrency tokens and related funds. The goal is to avoid the potential disaster of moving client assets into a doomed decentralized finance project or hedge fund or advising them to use an exchange or crypto broker that is borderline insolvent.
So how can we avoid all the dumb mistakes that leave us vulnerable in the midst of a crypto winter? There are a variety of ways.
Understand funding and backing
For digital asset exchanges, adequate funding means that there’s enough in the pot to handle liquidations. In the world of decentralized finance, it is the network of participants who help keep projects afloat. In the recently treacherous realm of stablecoins, it’s the collateral backing the project.
Know the developers and founders
The early blockchain and crypto industry was a haven for anonymity. We still don’t know who is Satoshi Nakamoto, the inventor of the Bitcoin blockchain. But after 13 years of growth and evolution, investors shouldn’t be kept in the dark about who is creating tokens and protocols. Projects with identifiable founders, developers and leaders are less likely to end up as money-losing schemes.
Read white papers
Not only are founders, developers and leaders mostly no longer anonymous, they are also in regular contact with the communities of investor-participants they are creating. In most digital asset projects, this communication starts with a whitepaper that explains what the project is intended to do.
This isn’t as cut and dry as it should be. Some projects founded without much rationale to begin with – like Dogecoin and Shiba Inu – have taken on a life of their own. Meanwhile, others with very clear and well-communicated rationales have failed – like Terra. By and large, reading these white papers will aid our discretion.
Apply common sense
Consider the old investment adage,“ If something seems too good to be true, it probably is.” This holds true in the crypto universe as well.
The problem is that many new entrants into the crypto space set overly high expectations. They compare themselves to early entrants into bitcoin and ether (ETH), who reaped returns in the thousands of percent.
The reality is that the speculative days of digital assets are quickly coming to a close, and the opportunities for huge returns over short time periods have become fewer and further between.
Take yields for example. As more people participate in decentralized finance (DeFi), the yields and income being offered by such projects should also come back down to Earth. If something purports to offer a yield of over 10% annually there had better be a good reason why it is able to do so, and that reason should be found in the documentation sent by the project’s leaders and developers.
Clients of advisors may see the pie in the sky and seek out opportunities for huge returns and high yields, but advisors have to assess if the returns and yields are sustainable.
Consider cold storage
Recall the difference between hot and cold storage. Hot storage occurs in active wallets, on crypto exchanges or with crypto brokers. Cold storage, on the other hand, is held in offline devices by the owner/investor of the crypto. Cold storage is the most secure way to hold cryptocurrencies.
If an advisor or investor has legitimate concerns their crypto broker of choice might suffer from liquidity issues or bankruptcy, a move to cold storage may be the best way to keep assets safe.
Pay attention to regulators
If managing volatility and helping clients avoid bad projects is too much work, regulators are almost certain to step forward to respond to some of the struggles in the crypto space. This will offer some much-needed clarity and stability to crypto.
The problem is that advisors can’t afford to wait for regulatory clarity to appear. Many of their clients are already invested. Still, it’s the advisor’s responsibility to keep up with the regulatory narrative around digital assets and help their clients steer clear of tokens and projects that may be killed, harmed or radically altered by regulation.