Crypto market can learn lessons from traditional risk management

DUE TO the plunge of the crypto market this summer, highlighted by the collapse of the TerraUSD stablecoin and the insolvency of crypto hedge fund Three Arrows Capital as well as centralised finance platforms Celsius and Voyager, regulators are paying more attention to it than ever.

These bankruptcies and significant losses expose a key, even basic, financial principle: the risk-return relationship. This relationship implies that to take on higher risk, investors typically require a higher return. Numerous entities in the crypto environment offered annual percentage yields north of 20 per cent, rates unheard of in traditional finance. While high yields are nice, investors would be wise to ensure they understand that they are taking on higher risk.

One of the virtues of decentralised finance is that the individual has complete control over their investments. But at what point does that control start to become risk-return negative? Too much risk can lead to a collapse of the system because the continuous returns associated with the undisclosed risk become untenable over time. This leads to a need for a risk management mindset, coupled with risk management methods, in crypto finance.