Recently, the crypto market suffered its worst crash in value since 2014, leading many to believe that a bubble has finally burst for the market. Due to the fear and uncertainty that now surrounds these coins, many investors wondering what to do next.
Over the next few weeks, it could be a good idea to start re-evaluating your approach to these digital investments, and the methods used to arrive at your conclusions. Just buying whatever is suggested to you on Twitter or Reddit, or jumping from one coin to another is not likely to work in future.
However, there is some good news: we have inched our way closer to the long-term moving average of the market, making it healthier for new entrants. However, there is also some bad news: the FOMO hysteria could continue to get worse if some long overdue problems are not addressed.
One of the major concerns right now is what is happening with the crypto Tether. But there could be some relief on the horizon as the SEC and CTFC are both having meetings on the 6th of February to decide what they’re going to do with the rogue platform.
Although nobody knows here the bottom is for the crypto market, we may have passed the dip of irrational exuberance (boom) phase of its life cycle and entering a more mature period. This will hopefully give investors some breathing room and time for some serious introspection about their investments.
With things as volatile and uncertain as the crypto market, the best thing that people can do is to take everything as a learning experience. It’s not useful to point fingers. It’s this kind of short-sighted behaviour that was rewarded when things were going well for everyone (in a bull market). These actions could only take us to where we are now. Unfortunately, the same hype that lured investors to the crypto market to begin with is the same fear that will lead them to blame others for the bubble’s deflation.
Anyone who put money into shill coins without any use case should accept that their own misjudgements were the cause of these currencies being overvalued to begin with, which led to an eventual crash.
So, if you are looking to pick up the pieces and start over, here is a 2018 Cryptocurrency Crash Recovery Tips guide that you can follow:
First of all, if you are doing any kind of investment, then you should lead in with a proven strategy.
Without going into too much depth to start with, below are some simple yet proven tips that everyone should work into their strategies and portfolios.
- Speed up to slow down: research every cryptocurrency before buying them for at least 1-2 weeks.
- Don’t buy a coin just because it has gone up in price.
- Don’t exit a position just because it has gone down in price.
- Invest as much as you are willing to lose and nothing more.
- Prepare your entry and exist strategies before you start trading.
First of all, start by thinking about your desired return on investment target, your hold periods on each position, and how much you’ll put on the table.
The majority of new investors have whimsical expectations that surround the returns they expect. The majority of new investors have also never put their money into any form of financial asset, which makes the idea of earning a 5-10% return on investment boring.
Yet it’s important to understand what were the factors that lead to such a huge amount of growth over 2017 and that it is improbable that we’ll see 10x returns for next year. What we witnessed was conceivably the Greater Fool Theory played out to perfection. This can make a 5-10% ROI each month not so satisfying, although they are at a much healthier and realistic level than before.
You can set a target in terms of the market return on investment over a certain holding period and then add or decrease that number as you customize your risk profile.
How to Calculate a 2 Year ROI Target
For example, lets imagine that you intend to hold on to your coins for an extra 2 years from now. How would you then set a realistic target?
One way is by viewing the returns of cryptocurrencies over the last 2 years as a starting point. Ideally, that number should be during a similar market period to what we are experiencing now.
Since we had a price correction in 2018, it might be wise to look at the 2 years between 2015 and after the correction that happened in 14.
To do this, we will calculate what’s called the compound annual growth rate (CAGR) over the 2 year period.
Year Total Market Capitalization
- Jan 1, 2015: $5.5 Billion
- Jan 1, 2017: $18 billion
With these figures, this leaves us with an annual return of 81%.
This figure of 81% works out to be approximately 4.9% compounded every month. Alarmingly, this figure might be considered small by some, especially as some altcoins increased more than 10,000% in last year alone. Yet these numbers will keep your expectations realistic.
You can however, play with some of these numbers if you’re aiming for a greater return (2x of 81%). This would involve buying riskier positions than normal. We can’t tell you what target you should be aiming for, as that will be reliant on too many factors to mention here. But ensure that your target is not anchored to parabolic price increases in small-capitalized altcoins, as that will not work over the long-term.
Once you have your targets set, you can then work on building your profile. You should have both low risk and high risk coins in your portfolio that is customized to hit your ROI target.
It would be fair to say that every investment you make with cryptocurrencies will expose you to some kind of risk.
Yet it might be helpful to break down that risk into 3 different risk categories:
- Low risk Holdings: These coins are those that are have been around for a while and have a feasible use case. These coins are also likely to still be here in the next 5 years, and have the strength to bounce back after a bear market. Some examples of low risk holdings include Bitcoin, Litecoin, Ethereum, and to some extent, Monero.
- Medium Risk Holdings: These are coins that seem feasible and have an established base of traders. They are, however, riskier than portfolio staples such as Bitcoin. Names like ZCash and Ripple come to mind for medium risk holdings.
- High Risk Holdings: Anything released over the last few months, especially by airdrop. ICOs, low cap cryptos, and shill coins. Most of what is bought and sold in the crypto market should be considered high risk.
With the above categorizations in mind, the question then is how much risk should you expose yourself to? The answer is that only you can decide this for yourself. It also depends on how much experience you have with buying investments in the past, as well as your financial and technological expertise.
Despite this reality, here are a few starting points:
- 50-70% for inexperienced traders in Low Risk Holdings. You can then diversify your portfolio as you gain expertise and confidence.
- You should keep at least 1/3 of your portfolio in low risk holdings.
- Do not put all your money into speculative coins.
Here are some additional strategies and principles about managing your risk that you should adhere to:
- Split your holdings across different industry sectors and rebalance sporadically.
- Think about using the dollar cost averaging model before entering a position. In practice, this means you invest only a certain amount of money over several periods, as opposed to everything at once. You’re also able to use biased dollar cost averaging to hedge against dips in the market. For instance, instead of putting $1,000 of your money in right away, you can purchase $500 at its given price and then setup a few limit orders at different intervals ($150 at 7% lower than market price, $250 at 12% lower than market price). This means that your cost per buy will be lower if the price of the coins goes down in the interim.
- It’s important to not have between 7-10% of your total worth in cryptocurrencies.
- Ensure you have most of your investments in coins that you feel confident about holding over 2 years. Do not use most of your investments for day trading.
- Keep in mind that you won’t make any profit until you actually make a withdrawal from your exchange. The best time to do so is at the peak of the coin’s value, when everyone else is panic buying.
- Keep some cash in reserve at an insured exchange such as Gemini. Then be ready to add to those winning positions during a pullback. This is important for your entry strategy.
- Think about how much loss is unacceptable to you on a high risk position, then issue your stop limit orders to protect your investment from crashes. Assign your stop price floating at around 5-10% of your bottom limit. Although they are imperfect, stop-limits can be a good way of hedging your investments, especially in cases of a severe market correction or a coin with a tiny microcap.
One way of thinking about cryptocurrencies is that each has an individual risk factor that is also tied in to the risk of entire crypto market. Additionally, cryptocurrency has an inherent risk for its own objectives.
The market risk of cryptocurrencies unavoidable. This risk is taken by the whole market, and can be affected by events such as regulations. What you can do, however, is minimize the risks of your individual cryptos and portfolio. The risk profile of a coin is determined by factors such as its team composition and sometimes geographic location (for example, the NEO coin has risks from it being banned from regulators in China).
What coins to choose in your portfolio?
Besides thinking of your portfolio and the coins in them as different risk categories, it is also helpful to consider the different market segments you are buying into.
Cryptocurrencies can loosely be broken down as the following:
- Core Holdings: BTC, Ethereum, Litecoin etc.
- Platform: Ethereum, NEO etc.
- Privacy: Monero, ZCash etc.
- Finance: Ripple, Stellar etc.
- Enterprise Blockchain: Vechain, Walton etc.
- Promising technology: NANO, Railblock etc.
Another useful exercise is to consider your circle of competence. This means that you should only invest in coins that exist within the sphere of your expertise. The ability for you to evaluate the risk and potential of your coins will come down to how well you understand the subject matter. In other words, if you don’t know enough about the function of supply chains, how could you judge if Vechain will achieve success? If you don’t know enough about technology when you examine Cardano, how will you know if it’s able to be used?
Also examine the historical price movements between the coins you are holding. As a general rule, when Bitcoin increases in price, altcoins decrease. Yet at what rate and amount comes down to the type of coin. When Bitcoin’s movement is static or moves laterally, we usually see a pump in altcoins.
It’s important to spread out your holdings and diversify – limited to 12 cryptos in your portfolio Holding anything more than 12 coins at a time makes it impossible to accurately judge the amount of risk you are exposing yourself to. If you have more than 20 different coins then it could be a good idea to consolidate those into others that you understand better.
How to Choose a Cryptocurrency
If you find it hard when it comes to analysing the best cryptocurrencies for your portfolio, then here is a step by step process that you can follow.
Step One: Filtering and Research
There is so much hype and talk out there that it can be easy to be overwhelmed. A great start is to consider your portfolio allocation strategy and how you’d like to maximize its returns. One example that comes to mind is business-focused solutions for the blockchain, as they will be pivotal over the next several years. Many successful investors build a list of coins that rest in that segment.
Once you have created a “target list” of potential coins, then it’s time to do your research about them.
- Go through the website carefully. If it’s nothing but nonsense and buzzwords, if it’s poorly made or designed, then stay far away. Look for a roadmap, and compare the roadmap to what the company has done so far. Check the credentials of the team, and look them up on Linkedin and their past experienced.
- Remember to read the whitepaper and business development plan. By the time you have finished reading these documents, you should have a clear idea of how the cryptocurrency works and the methods it will create value. If there is no feasible use case or if the platform does not need the blockchain, stay away.
- Look the company up on Blockchain Explorer. How will the tokens be distributed across accounts? Are some of the major accounts selling off? Figure out who the major holders for the coins are (the whales) and how many coins the founders and team are getting from the ICO.
- Look at its Github repository. Is its community empty or are there plenty of changes being made?
- Hunt for the company’s subreddit and go through the Medium or Steem posts about the coin. Does the community look like shills? And is there much engagement between the company and the wider community?
- It’s also advisable to look through its Bitcointalk threads, as well as twitter mentions. Determine the quality of conversation going on.
Just by doing the above you can weed out most of the scams and shillcoins.
Here are some more red flags to keep an eye on:
- Distribution of tokens that give too many tokens to the founder.
- Guaranteed returns.
- Poorly written white papers that contain nothing but buzzwords and platitudes.
- Timelines that don’t make sense or are unrealistic.
- Github that is empty or only has limited activity.
- A team that is anonymous or hard to source information about.
Step Two: The Checklist
Once you’re sure that the ICO is not a scam and is worth taking further, your job is not yet done. You should then put the ICO through an additional checklist of questions.
- What is the problem that the coin attempts to solve?
- What is its development team like? What are their reputations? How are they being funded and organized?
- How big is the market that they have segmented?
- Who are their competitors and how does the coin do it better?
- What roadmap are they following and how well have they adhered to it?
- What product exists currently?
- How does the coin holder get value from its issuance? Are the coins using a staking process or is transactional?
- Is there any new technology released by the firm?
- Can the new technology be duplicated easily?
- What are the weaknesses or potential issues of the coin?
The last question in the list is especially important.
Using the list, this is how you can measure how risky the investment is. You should be able to place the coin into one of the 3 risk categories mentioned earlier. It’s also useful to go over this checklist for each benefit and think about what features of the blockchain are being used by the coin in question.
The Benefits of Cryptocurrencies
- Decentralized – Eliminates the need for an outsider to verify transactions.
- Transparency – Everyone can see all trades on the blockchain as they happen. This can be useful for some platforms such as an online casino.
- Immutability – Difficult for a user to change the status of a transaction once it meets the blockchain.
- Distributed availability – The system is stretched across hundreds of nodes on a peer-to-peer network, making the system secure.
- Security – Secures transactions for enhanced integrity.
- Consolidation – The blockchain can be shared across businesses and even entire industries. Helpful for when information was originally “siloed” in isolated databases.
- Fast Settlement – A blockchain increases the speed of verification of data across the network.
- Cost – Sometimes a key benefit of using a blockchain. Can help avoid paying third-party fees for verification and may reduce costs.
Step Three: Evaluation Model
You don’t need go into financial modelling to invest in cryptocurrencies, nor do you need to have a background in finance. Just a simple model would suffice to derive a valuation of the coins. This will put you far above most crypto investors.
Here are some simple methods that anyone can put into practice:
Probabilistic Scenario Valuation
This involves considering different scenarios and their probability of occurring. It can be a great thinking exercise by itself. One example is Billet Miller, who is a famous value investor, wrote a valuation case for Bitcoin in 2015. In his study, he came to 2 possible scenarios for probalistic valuation:
- Evolving to a store of value, similar to gold (6.7 trillion value), with a .24% probability of occurring
- Phasing out payment vendors such as Visa & MC ($300 million dollar valuation) with 2.4% probability.
Putting these scenarios together would leave you with an expected market capitalization. (0.24 x 6.7 trillion) + (2.4 x 300 million). When you divide these numbers by the amount of outstanding supply you will get your bottom line valuation.
Metcalfe’s Law is a principal that states the value of a network is determined by the square of the number of users in it. So, you can look at various currencies based on their market cap and the square of active users or website traffic.
It’s possible then to alter this equation for cryptocurrencies by considering the number of users and transactions.
One way of looking at it is the greater the ratio, the greater the evaluation given for each address and transaction.
Market Cap and Industry
Another simple method is viewing the total cap of the market that the coin is in and then comparing it to the market cap of the coin. You can think of the market cap not just with circulating supply, but also total supply.
One example is Dentacoin, which has 1,842,395,638,392, coins in circulation. When this figure is multiplied by its cost in Jan, we can see a market cap is much bigger than the industry it attempts to disrupt, which is dentistry.
Other Valuation Models
If you are interested in trying your hard with some more complex models built in Excel, one recommended resource is Chris Burniske’s blog about using Quantity Theory of Money for building an equivalent DCF analysis for cryptocurrencies.
A good practice is to create more than one scenario with different assumptions, weighing in on the pros and cons. Use a baseline that is somewhat positive and negative, and some others that are highly negative and positive.
Most investors want to see at least a 50% potential moving in the positive direction before putting any money down. But your own risk tolerance will be up to you.
The great thing about financial modelling is that it’s not really the price of valuation comparisons it leaves you, but rather it forces you to consider why and how a coin has gone up or down in value, and what your expectations are for the future. For example, the discount rate that you set for the net present utility calculation dramatically affects the valuation of the currency, which then reflects back your personal assumptions about how risky cryptocurrencies are.
What discount rate can you accept? How about the virtual economy you are assessing for the coin, what features of the market will affect is adoption and how likely will you right about those assumptions?
With these questions in mind, you’ll be a significantly more switch-on investor if you can pinpoint the underlying variables that give your coin the capitalization you think that it should keep.
2018 Cryptocurrency Crash Recovery Tips Summary
The pie in the sky fantasizes of becoming an overnight billionaire could be over, but that is no reason for you to feel upset; the market correction we’ve just witnessed is something that many enthusiasts were waiting for.
Using the above guide, you will be able to construct a new portfolio that takes into consideration your risk and return targets. Before you start trading, you’ll go through a process that evaluates what kind of coins you’d like to hold on to based on what you know about each industry segment. As always, nobody can tell you what coins to buy, as you should decide that for yourself and do your own research.
As long as you keep to a rational and proven strategy, then you will feel more comfortable about your investments, even amidst a correction like we have experienced now.