Crypto Chaos: Are You Making These Risk Management Mistakes?

In the fast-paced world of cryptocurrencies, volatility is the name of the game. The huge run-ups to new all-time highs can be thrilling, but the sudden drops? Not so much. This is where the art of crypto risk management comes into play, and it’s crucial for any trader or investor who wants to stay in the game.

Common risk management strategies in the crypto world include diversification, setting stop losses, and using put options. These strategies can provide a safety net, but they’re not without their limitations.

In this article, we’re going to dive into the most common tools found in the crypto world and introduce a new disruptive DeFi platform for managing risk.

Put Options

Put options are a type of derivative that give the holder the right, but not the obligation, to sell an asset at a predetermined price within a specific time period. There are two ‘flavours’ of options, and we’ll be talking here specifically about put options, which can be used as a hedge against potential price drops.

Here’s how it works: Buying a traditional put option gives you the right to sell your asset at a certain price (the strike price) at a future date. If the price drops below the strike price, you can exercise your option and sell your asset at the higher strike price, effectively limiting your losses.

When you purchase a put option on a crypto options platform like Deribit, for all intents and purposes it looks as if you’re securing the right to sell your crypto asset (e.g. Bitcoin) at a predetermined ‘strike’ price, at a future date. However, on Deribit, and most other crypto options platforms, you don’t actually sell your Bitcoin when your put ends up ‘in the money’.

Instead, most crypto options platforms operate on a cash settlement basis, meaning you’re paid the difference in cash rather than transacting in Bitcoin. Thus, crypto options generally do not protect your actual tokens.

In fact, you don’t even need to own any tokens to purchase an option, you simply need to pay the premium. Essentially, options are just another form of betting on price movement, but they are highly complex and for many users very difficult to understand.

Moreover, while there are a number of platforms which have made crypto options more accessible, they are still relatively new and come with their own set of risks, and many of these platforms are centralised and often unavailable in certain jurisdictions, including in the USA.

‍Diversification

Diversification is a key strategy in any form of investment, and it’s no different in the world of cryptocurrencies. The principle behind diversification is simple: don’t put all your eggs in one basket. By spreading your investments across a variety of assets, you can mitigate risk and potentially increase your overall returns.

Diversifying your crypto portfolio can take several forms. One common approach is to diversify across different assets and even different asset classes. For example, you might invest in a mix of cryptocurrencies, DeFi projects, stablecoins and blockchain technology companies, and this can help protect against sector-specific risks.

However, it’s important to note that diversification is not a guarantee against loss. The crypto market as a whole is highly volatile and can be influenced by a wide range of factors. One major factor is the price of Bitcoin — as the number 1 crypto which accounts for around half the total capitalisation of the entire cryptocurrency market, Bitcoin quite often front-runs other smaller tokens, and what Bitcoin does, the Altcoin market tends to follow. Thus diversification is not necessarily a foolproof strategy for risk management.
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Stop Losses

Stop losses are another common strategy used in crypto risk management. A stop loss is an order placed with a broker to sell a security when it reaches a certain price. In the context of cryptocurrencies, a stop loss can help limit potential losses if the price of a crypto asset drops significantly.
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While stop losses can be a useful tool to protect against sudden market downturns, they’re also not without their drawbacks. One of the main challenges with stop losses is that they can lead to premature selling. As Crypto markets are notoriously volatile, short-term price fluctuations can trigger a stop loss order, causing your assets to be sold even if the price recovers shortly after.

Another issue is that in fast-moving markets, the actual selling price may be lower than the stop loss price, resulting in larger losses than expected.

Finally, relying too heavily on stop losses can lead to a false sense of security, and it’s important to note that they are a tool designed to limit losses, not to make or maximise profits.

The New DeFi Risk Management Solution: Bumpering Your Crypto

Enter Bumper, a new kid on the block(chain) that’s changing the game in managing crypto risk. Bumper allows users looking to hedge against downside volatility to set a floor price for their crypto assets, protecting them from market crashes and downside price movements, while still allowing them to ride the wave should prices increase.

So how does Bumper work? It’s simple. On the Bumper dApp, users choose a floor price (similar to an options strike price) and a term length, then lock their tokens into a pool via the dApp directly from their web3 wallet.

If the price ends up below the floor when the term expires, they exit claiming stablecoins at the value of the floor.

If it’s equal or above the floor, they retrieve their original asset back.

Either way, they pay a premium, which is calculated incrementally based on market volatility, and which is applied to the whole pool of locked tokens. This has the effect of minimising premiums to a ‘fair’ value which is calculated and executed by the protocol’s smart contracts based without the need for third-party intermediaries or trying to figure out complex mathematical algorithms.

On the other side of the market, Bumper provides a solution for stablecoin holders seeking to earn an attractive yield on their holdings. Users can deposit their stablecoins into a separate contract, which is also pooled, and which pays out claims from those seeking protection.

In return, this pool earns the yield from the premiums paid by those who want protection. Pooled liquidity also has the upside of spreading the risk out for these depositors, and the system is balanced at all times to ensure that fair premiums create a fair yield for users on the other side.

Bumper has spent a number of years in Research and Development designing, testing and recalibrating their algorithms to ensure the balance between minimising premiums for protection seekers and maximising returns for yield seekers, as well as making sure the protocol is always able to meet its liabilities and stay solvent, and here you can find out more about the results of these extensive simulations and historical back-tesing.

Bumper launches in August 2023 on the Ethereum mainnet. Find out more by reading the Litepaper.

Ready to take control of your crypto risk management? Join Bumper’s community today and be among the first to protect your crypto assets from market volatility while still enjoying the upside. Click here to join our Discord!

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