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Key Risks of Cryptocurrencies

Key Risks of Cryptocurrencies

There are primary risks and secondary risks present with any asset class and cryptocurrency is no exception. The spot asset, meaning any cryptocurrency asset that is not a derivative or of a futures type, is what we will examine in this context. Primary risks will affect the daily mark to market (MTM) of an asset (these are often also referred to as 'Market Risks'); while secondary risks, although present, may not be easily or tangibly measured through price alone. Most of the risks examined and reported daily by our analytics team are primary (Market) risks.

Primary risks include volatility, liquidity, and the underlying asset itself. Volatility risk refers to price movement that is adverse to a given position. It is important to pay attention to volatility levels in order to make informed estimations surrounding potential or reasonable near term price movements. Liquidity is often thought of as the life or blood of the markets; it helps the market function smoothly as intended. Why is this so? For every buyer, there has to be someone on the other side of the transaction willing to sell at that price. A lack of buyers or sellers limits the ability to move freely in and out of positions without much slippage in price. When liquidity levels are weak or declining, it implies an unhealthy market to invest or trade. Low liquidity levels can also exacerbate price movements. The underlying asset is a primary risk because a change in the price itself each day can lead to wide and varied profit and loss impacts in USD terms.

Primary risks will affect the daily mark to market (MTM) of an asset

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Secondary risks include items like legal risk, operational risk, network risk, custodial risk, reputational risk, tax risk, and risk of theft or loss of physical storage if applicable. These risks are often hard to measure at any certain point in time absent a major event trigger, but all secondary risks would have a severe impact on price immediately. Let us define the long list of secondary risks. Legal risk refers to the risk of loss arising due to legal enforcement or action taken against a token, exchange or other regulatory action impacting an asset. Network risk refers to the risk of loss arising due an assets’ network becoming compromised by attackers or no longer supported by miners, reducing functionality and utility. Operational risk refers to the risk of loss arising due the human component or user. A typical operational risk might arise from a user sending $ or an asset to an unintended or incorrect address. Custodial Risk refers to the risk of loss arising due to a custodian or 3rd party who is entrusted to hold your cryptocurrency asset. Reputational risk refers to the risk of loss due to a news event that damages the reputation or utility of the asset. Tax risk refers to the risk of loss due to changing tax circumstances in the space. And finally, there is a risk of theft or loss if physical storage is involved.

This post is meant to be an introductory discussion of cryptocurrency risks, and certainly is not inclusive of every knowable or unknowable risk present. There are additional risks that apply to derivative or future's contracts on cryptocurrency, and those will be discussed in a later article.

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