Rules of Thumb to Navigate the Choppy Waters

Crypto crash: It is going to take time for risk appetite to return once the markets do hit bottom, says Margaret Paproski, Co-Founder of InvestDEFY

Over the last few weeks, we have experienced the worst bear crypto markets in quite some time. The prices of Bitcoin (BTC), Ethereum (ETH) and altcoins have taken a beating. Some big crypto names have crashed or faced a liquidity crisis, including Terra/Luna, Celsius and most recently, Three Arrows Capital. With more casualties likely to emerge in the coming days, weeks and months, is there a way to navigate this crypto crash? 

Crypto crash: Rules of Thumb

It is important to remember that investing in cryptocurrencies continues to be a highly volatile and high-risk investment that is not suitable for many investors. For example, one month implied volatility for BTC is 141 and one month implied volatility for ETH is 186. This is in comparison to the one month implied volatility for the average G10 currencies, which is 9.5 (although the volatilities of all three have increased as of late).

Any time you are investing in something where you are hoping for a 10x or 100x return, which is in no way the norm, that investment will come with significant risk. Therefore, only deploy risk capital that you can afford to lose. If you decide you want to gain exposure to the crypto markets, here are five rules of thumb:

Understand what you are investing in

Are you buying BTC, ETH, or Altcoins? Are you holding onto those investments in your wallet or are they sitting with a given venue or on an “exchange”? Have you staked your assets, loaned them out or otherwise deployed them to earn a return beyond the potential appreciation? If you aren’t keeping your investments in your wallet, have you considered the counterparty risk? Do you understand how your capital is being used? Do you know that crypto venues and “exchanges” are generally not covered by any insurance or protection similar to SIPC protection?

These are all questions to be considered. Historically, it has been hard to get a real peek under the hood to understand how your capital is actually being deployed. Hopefully, one of the benefits of this recent crash is increased pressure on venues and “exchanges” to provide more visibility to account holders on how the capital is being deployed. Do your homework and ask questions before you decide whether to deploy your capital into a given venue. 

Accept that unless you are lucky, you won’t be able to time the markets exactly.

We know that prices are down at the moment, but have they hit the absolute bottom? Probably not. No one really knows. Don’t go into these markets with the belief that you are a professional trader and can time the bottom or top of the market. Consider it to be a great success if you can capture 60% or more of the move.   

Don’t try to actively trade these markets unless you are a specialist.

These markets are highly volatile and operate 24/7/365. You might go to bed thinking you put on a great trade only to wake up to a significant loss. The fact that these markets operate 24/7/365 is a very important distinction from traditional finance markets.  

Avoid leverage now – and probably always.

These are highly volatile markets. 

Be aware of your investment time horizon.

The closer you are to wanting to use your investment dollars, the less risky and less volatile your investments should be.   

Crypto Crash: Navigating the Choppy Waters

In trying to navigate the choppy waters, it is important to remember that crypto markets do not operate in a vacuum. There is a correlation between what is happening in the broader financial markets and what is happening in the crypto markets. Right now, the Fed is raising rates at historical levels. The Fed just raised interest rates by 75 basis points, which is the single biggest increase since 1994. With the tightening market support, markets across the board are going down.

As it relates to the crypto markets, the dominance of BTC is likely to continue whether cryptocurrency prices rise, fall or stay the same. The general expectation is that once the crypto markets bottom out, the price of BTC is likely to start rising before the price of ETH and certainly before the price of altcoins. Due to the dominance of BTC, if you are looking to start gaining some exposure to crypto, one strategy is to deploy a portion of your crypto investment dollars into BTC and a portion into stablecoins (stablecoins with sufficient reserves as collateral) or alternatively, to keep a portion in cash. 

Another strategy is to buy a bit of exposure on an ongoing basis rather than trying to time the market exactly. This gives you the benefit of dollar cost averaging in order to grow your stack. Therefore, if today the price is low but next week or next month the price is even lower, you have not put all of your eggs in one basket. Similarly, if you are looking to adjust your position, try to do so in tranches and not all at once. As the price of BTC rises, there may be an opportunity to shift some of your crypto exposure into ETH and/or altcoins depending on your investment horizon.     

Crypto Crash: Recovery Isn’t Linear

It is doubtful we will see a V-shaped recovery. It is going to take time for risk appetite to return once the markets do hit bottom. Therefore, don’t jump in because of FOMO (fear of missing out) on the assumption you will miss the recovery. The recovery and accumulation stage will take time. Bear markets often continue much longer than initially expected. Sometimes the best thing to do is nothing. You don’t have to hold a position.

Over the next while expect that any increases in the price of crypto will be followed quickly by a price drop as those looking to reduce their exposure or those wanting or needing to liquidate will try to take advantage of any price increases. 

About the author

Margaret Paproski is the Chief Operating Officer, General Counsel and Co-Founder of InvestDEFY, a sophisticated structured products company driving the evolution of crypto investing. Margaret holds a diverse TradFi acumen, with over 20 years of experience as a lawyer, CPA, CMA, and financial professional. Prior to co-founding InvestDEFY, Margaret served as General Counsel for the Midnight Sun Financial group where she oversaw the issuance of $3B in structured financial products over three years. Margaret previously practiced tax law with a focus on corporate reorganizations, acquisitions, and divestitures, and she was an investment banker at Lehman Brothers in the US for five years. Margaret holds an MBA with Distinction from the Kellogg School of Management.

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