The collapse of FTX in November 2022 sent shockwaves across the industry. Rivalled as one of the largest bankruptcies of all time, alongside the Enron scandal.
In situations like these, there are always lessons to be learned. At DefiDive, our team discusses ways in which we, as an industry, can move forward. Drawing from our collective experience, here are 5 tips you should know before getting into crypto.
- Risk Management - consider high, medium and low risk
In recent years, bankruptcies and crashes have impacted companies like FTX and projects such as Terra Luna, resulting in substantial losses for many investors. The promise of stable returns led many to deposit funds, while the substantial size of the companies and projects contributed to the misleading perception of a safe haven.
Effectively managing a portfolio requires an understanding of different types of risk. All investments involve a degree of risk and should be clearly understood. In the losses mentioned above, it's easy to see that, in hindsight, counterparty risk should have been scrutinized more closely.
We recommend that all crypto investors consider the crypto allocation of their portfolio to be marked down as high-risk investments.
Lesson 1: Classify crypto investments as high-risk in your portfolios.
- Counterparties
“Don't put all of your eggs in one basket” - this common saying emphasizing the importance of diversification. Meaning that if you concentrate all your resources or efforts into doing one thing and it fails, you'll have no alternatives left. While this lesson is often passed down through generations, applying it can be challenging.
In crypto, what this means, is if you deposit all of your tokens on a single centralized platform such as FTX, and it goes bankrupt, then you have little alternative then to wait and see what happens.
To be more proactive, take some time to learn about counterparty risk. In the world of finance, assessing the risks associated with each person, company, or wallet provider you engage with brings you closer to a well-managed portfolio, with your eggs spread across multiple baskets.
Lesson 2: Spread your counterparty risk.
- Financial Health Check - outside of crypto
Acknowledging that crypto is high risk is not enough. We frequently skip past the disclaimers asking us to not invest more than we can lose, but what does this mean practically?
When we talk to those wanting to get involved in crypto, we often have to start with an uncomfortable conversation about personal finances.
Do you:
- Have a couple of months' worth of living expenses saved up in case of an emergency?
- Have other savings in the form of a pension, fixed deposits, funds or stocks?
- Are your mortgage and other loans budgeted well, and payments manageable?
If the answer to all these questions is yes, then you are in a good position to consider using excess savings to invest in higher-risk assets such as crypto.
Alternatively, we often see the following scenarios:
- Relying on crypto gains to help you retire
- Putting all your money into a risky investment with the promise of high returns to pay off your living expenses, mortgage and other loans
- Borrowing money to invest before paying it back later
If that describes you, then it's difficult to recommend taking the risk with money you can't afford to lose. We would encourage you to start with the basics of budgeting.
Lesson 3: Take care of your personal finances before investing into crypto.
- Losing more than you can afford?
You're doing it wrong. What is becoming apparent are the number of individuals in despair complaining about life savings being lost. Crypto Twitter is full of stories of those with life savings lost in the FTX collapse, yet the life lessons seem to have been forgotten from just a few months before in the Terra Luna collapse.
Lesson 4: Only invest in what you can afford to lose.
- Getting into crypto for quick gains or for value?
If you want to invest in crypto, consider whether are you investing for quick returns or for long term value?
Often times, people who invest with the intention to get rick quickly ends up losing more.
However, if you believe in the technology and potential value blockchain can provide in revolutionizing the current economy and financial system, you are more likely to succeed.
Be prepared to hold your tokens for at least 1-2 years as the trend evolves.
Lesson 5: Invest in crypto for the value, not quick gains.