Over the past decade, the cryptocurrency market has been questioned about its extreme volatility. Its decentralized nature has always been a double-edged sword for users and exchange platforms. It’s no wonder that many investors have emerged victorious and become millionaires quickly. But its high unpredictability can deplete the wealth of others, given its susceptibility to a market bubble.
The cryptocurrency market offers unique opportunities but presents investment risks not often encountered in traditional financial markets. Sharp crypto price changes, technical complexity, and minimal regulations can overwhelm investors. However, investors can cope with volatility with tried-and-tested strategies, prudent diversification, and thorough research. Even better, these can generate high returns in the long run.
With that, newbies must weigh the risks and returns of investing in cryptocurrencies before immediately entering the market. They understand the potential gains and losses of trading and holding cryptocurrencies. Most importantly, they must be prepared for the drastic changes in their investments. This article will discuss some tips to guide investors in crypto market investing.
1. Understand the Risks of Cryptocurrency Investing
Over the years, the cryptocurrency market has given exciting returns to investors. These were far higher than many other financial markets, especially equity or stocks. It was about ten times higher than the NYSE and NASDAQ primary stock indices. These are the S&P 500 (SPX) and the NASDAQ Composite (IXIC).
However, cryptocurrency volatility can be overwhelming for investors. While the sharp price increase can give instant wealth even for newcomers, sudden plunges may come when you least expect it.
Take the 2017-2018 cryptocurrency bubble burst as an example. On December 17, 2017, a single Bitcoin (BTC) reached $19,783 as its new all-high. But on December 22, 2017, BTC dropped below $11,000. In only five days, the value of a BTC decreased by 45%.
Market sentiments are also solid forces driving cryptocurrency changes. Amid the rumors about South Korea planning to ban cryptocurrencies, prices dropped more. It fell lower in the subsequent months, and even BTC could not rebound. At the end of 2018, BTC was only valued at $5,500, 72% lower than the all-time high price.
2. Weigh its Risks and Returns
You may have already had a glimpse of the market risks and returns over the past decade. As such, weighing the risks and returns of various cryptocurrencies is essential. That way, you can see which cryptocurrencies fit your risk appetite to optimize your risk-reward strategies. Doing so will also help you make prudent portfolio diversification to minimize risks and increase your potential to generate high returns.
You can do it across small-, mid-, and large-cap cryptocurrencies or between the cryptocurrency market and others, such as stocks and bonds.
Several methods can help you assess the historical returns of cryptocurrencies and compare them to their price volatility. You can even match them with the primary stock price indices to evaluate their potential returns and risks. The Sharpe Ratio can help you with your analysis.
| Bitcoin (BTC) | Ethereum(ETH) | Binance(BNB) | Dogecoin (DOGE) | Tron (TRX) | Market Average | S&P 500 (SPX) | NASDAQ(IXIC) | |
| Average Annual Returns | 146.26% | 47.02% | 103.12% | 58.00% | 83.48% | 87.56% | 12.12% | 16.08% |
| Risk-Free Rate | 4.00% | 4.00% | 4.00% | 4.00% | 4.00% | 4.00% | 4.00% | 4.00% |
| St. Dev. | 76.68% | 88.48% | 174.34% | 104.92% | 112.84% | 111.45% | 17.95% | 24.00% |
| Sharpe Ratio | 1.86 | 0.49 | 0.57 | 0.51 | 0.70 | 0.83 | 0.43 | 0.47 |
Clearly, the cryptocurrencies above had high returns over the years. Every year, they outperformed the stock market. Their drawback is their high standard deviation, which should not be surprising, given their wide price change dispersions. Despite this, their average annual returns outweighed their volatility, given their respective Sharpe Ratio.
3. Avoid Investing More Than What You Can Comfortably Lose
The cryptocurrency market is a relatively new and volatile asset that can increase or lose value in a single day. And even if the long-term trend has been bullish, skepticism remains in the market.
With that, investing the amount you are willing to risk and lose in case of a market downturn will be wise. It will be a strategic move while still testing the waters. As a rule of thumb, limit crypto holdings to 5% of your investment portfolio. Additionally, try setting aside adequate emergency funds, which will be allocated to cryptocurrencies.
Have a disciplined approach to cutting losses if your crypto investment drops by a specific percentage. Also, rebalance your crypto holdings in every particular period rather than letting them vary indefinitely.
4. Take Time To Learn the Technology
Learning and understanding how the underlying technology works and powers various cryptocurrencies is essential. These include blockchain networks, consensus mechanisms, smart contract functionality, and hashing algorithms. This step will help get a better insight into the market’s capabilities and limitations. You may also try to learn cryptography to better grasp solutions, such as zero-knowledge proofs.
Investing in technology to protect your data privacy will also be helpful. This is a crucial aspect to consider, given the market’s rampant hacking and data breach incidents. In 2023, the amount of crypto funds stolen reached $1.1 billion. On a lighter note, it has been in a continued downtrend since 2021, showing the conscious effort of traders to protect their devices and money.
Social media websites like Facebook, YouTube, Snapchat, and Instagram are some of those with the highest hacking-related incidents. Clicking links on the comments and messages gives hackers access to various information. Using similar emails and devices to make cryptocurrency transactions is even riskier.
As such, investing in tools that automatically eliminate suspicious messages and retrieve stolen data is essential. These can also help you determine how to unblock YouTube, Facebook, Instagram, and other accounts to stop hackers from accessing sensitive info.
5. Learn Dollar-Cost Averaging (DCA)
Apply the Dollar-cost average technique to crypto by making little but constant purchases on a specific schedule, whether monthly or quarterly. To make it easier, you can automate these through an exchange platform rather than purchasing manually.
This will help you cushion or lower the impact of volatility since it allows you to build a position methodically. Also, it enables you to avoid making impulsive decisions when there are rumors and biased sentiments. You will not fall prey to FOMO or fear of missing out and hype cycles.
Hence, you can control your spending on investments. You can even make opportunistic purchases occasionally, especially during market lows.
6. Deploy Various Crypto Indicators
Technical analysis can be far more challenging in cryptocurrencies than in stocks. Yet, it can still be used to make precise estimates and time entries and exits. Several tried-and-tested technical indicators, such as crossovers and moving averages, can give valuable price signals. Momentum shifts can also be identified by moving average crossovers. Investors may also combine technical indicators and blockchain analysis for a more comprehensive approach to price swings.
7. Beware Of Macroeconomic Changes
Over the past decade, investors have considered market sentiments the sole driving force behind price swings. But in the last two years, crypto prices have become more predictable. What has become more apparent is the market’s inverse correlation with inflation.
The graph below shows how major cryptocurrencies, such as BTC, ETH, and BNB reacted to inflation.
BTC
ETH
BNB
To prove our point, we can weigh their relationship using correlation. BNB has the highest correlation with 73%, ETH has 64%, and BTC has 62%.
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Given all these, we can say that inflation considerably influences cryptocurrency price changes. We can also understand that cryptocurrencies may not be an effective inflation hedge today. Yet, this increasing predictability allows us to make more prudent investment decisions.
Bonus Tip: Pay Attention to Regulatory and Governance Changes
Update yourself on relevant regulatory changes and legal cases. Legislative developments, domestically or internationally, are also significant. These can affect crypto adoption and prices. For example, BNB’s price dropped 8% four hours after its former CEO Zhang admitted its Anti-Money Laundering Act violation.
Bottom Line
Cryptocurrency trading and investing can be far more challenging than stocks and bonds. Risks can be exhilarating, but volatility can be overwhelming. That is why it is essential to take the necessary precautions before entering. But with proper knowledge and dedication, investors can succeed in the market.
