Cryptocurrency is an exciting way to make money and trade goods without having any middlemen take a slice of your pie. You’ll be able to do this directly from person to person using digital wallets and virtual coins instead of dealing with banks and financial institutions.
However, cryptocurrency businesses face some unique challenges that traditional businesses can handle.
As cryptocurrencies, including trading pairs such as LUNA USDT and SHIB/USDT, have become more popular, they’ve attracted much attention from financial professionals. But the SEC’s lack of regulation has made it difficult for traditional risk managers to figure out how to deal with them.
Cryptocurrencies come in many shapes and sizes. There are hundreds of cryptos on the market today. Because of this diversity, cryptocurrency risk management can challenge many investors.
For instance, some currencies have spotty performance records and lack a history of reliable data sets, while others have been around for years with steady trading patterns that make it easy to predict future performance based on past events. The challenges posed by such extensive variation among coin types will inevitably change how investors approach risk management.
2. Valuation difficulties
There are a few ways to value cryptocurrencies. The first way is to use a “model-based approach,” which assumes that cryptocurrencies are assets similar to stocks or bonds and can be valued by applying models used for other assets. Another method is called “fundamental valuation,” which entails estimating the fair value of each cryptocurrency based on its utility as a payment system.
The second challenge is valuing cryptocurrency derivatives, futures, options, and swaps. Investors need to understand how these instruments work because they can make or lose money depending on what happens in the market.
3. Regulatory and legal dilemmas
A third problem unique to the cryptocurrency space is more regulatory oversight.
Regulators are trying to catch up with this technology, but they need help to regulate it, and there are many unanswered questions about what rules should apply.
This can cause problems for investors and consumers who want more protection from bad actors in the industry.
4. Data and modelling obstacles
Historical trading data is often limited, which can be a huge challenge for crypto portfolio managers. The data may be incomplete or unreliable, not timely enough, not uniform across multiple entities or exchanges, lacking granularity and consistency of information, non-standardized (meaning it’s difficult to compare), or normalized into a common currency format (e.g., dollars).
5. Illiquidity and Trading Fees
While buying and selling cryptocurrencies at any time is an advantage over other investment vehicles like stocks, it can also cause problems for investors. Cryptocurrencies are not easy to trade in large quantities, which can make them illiquid.
And if you try to sell a large amount of cryptocurrency at once, you may need to find a buyer willing to meet your price. This means that trying to get out of your position before it turns into a loss could cost more than anticipated.
6. Issues with Custody, Clearing, and Settlement
Cryptocurrency is a new asset class and therefore has unique challenges. There are no regulations in place for cryptocurrency. No central authority can ensure they are not fraudulent or manipulated by a single party. Cryptocurrencies are not insured either, so losses due to theft or fraud cannot be recovered by an insurance company in the case of loss or theft.
Cryptocurrencies are also very volatile and risky because they may fall dramatically in value overnight. Even if you don’t sell any coins during this period because you’re holding them long term.
Finally, cryptocurrencies like Bitcoin still need to be liquid enough: You can only buy $10 worth of BTC at any given time (or more if you have multiple accounts). In addition, people who want to sell BTC often have difficulty finding buyers at current market prices because there needs to be more demand for large amounts of capital from investors who want access today rather than tomorrow/weekend, etc.
7. Risky Cryptocurrency Derivatives
You may wonder: “What’s the difference between a cryptocurrency derivative and an actual cryptocurrency?” Any government authority does not regulate cryptocurrency derivatives, so they are not traded on exchanges or in traditional markets.
Cryptocurrency derivatives do not have an underlying asset, like gold or stock; instead, they reference only the price of the underlying cryptocurrency. When you buy into these products, you use leverage to increase your returns (or losses).
Because these products aren’t traded on exchanges, there’s no way to know their value after purchase—and because cryptocurrencies aren’t backed by any physical assets such as gold or silver bars, they’re highly volatile.
The risk management challenges in cryptocurrency are real, and they are not going away anytime soon. Cryptocurrency is a new asset class with no historical data and no proven models for valuation. Its trading activity has some similarities to other financial markets, but it also contains unique characteristics that make it difficult to evaluate.
As a result, investors should be cautious when purchasing digital assets or entering into derivative contracts such as futures contracts on cryptocurrencies.