The 4 Crypto Investment Risk Levels

Every investment strategy comes with risks. The key to successful investing is knowing the levels of risk ... and your personal tolerance.

Why take on more risk? Because, as Chris Coney says in the latest Weiss Crypto Sunday Special, “Reward and risk usually go hand in hand.”

The risks inherent in the crypto markets are different from more traditional investments. According to Chris ...

The further away you go from base assets — like Bitcoin (BTC, Tech/Adoption Grade “A-”) or Ethereum (ETH, Tech/Adoption Grade “A”) — the more your risk profile increases. Now, while the risk level might go up in lockstep as you go further away from these base assets, the reward may not.

To learn more about Chris’s crypto risk level model, you can watch our latest Sunday Special, or continue reading for the full transcript ...

Chris Coney:

Hi there, guys, and welcome to this week's edition of the Weiss Crypto Sunday Special with me, your host, Chris Coney.

Today's topic is the logical levels of risk in crypto investing. Now, I thought it was about time that I addressed this concept directly. I have actually referred to this a number of times in other Sunday Special episodes, but I've never dealt with this concept on its own.

So, what this is — the logical levels of crypto risk, as I call it ­— is essentially a model that is a work in progress. I mean, as most of crypto is a work in progress. Now, this model of mine is based upon my thesis of that the further away you go from base assets, like Bitcoin or Ethereum, the more your risk profile increases.

Now, while the risk level might go up in lockstep as you go further away from these base assets, the reward may not always be a perfect reflection of the risk level. I always say reward and risk go hand in hand, but that doesn't mean they're a perfect reflection of each other. It's not always balanced one to one … one unit of risk to one unit of reward.

The sweet spot, as I've previously referred to it as, is when there is a risk-to-reward ratio that is more heavily weighted on the reward, and that sometime referred to as asymmetric risk-to-reward ratio: You want more chance of making a profit than losing money, and you also want to make more money than you could potentially lose. That's not symmetrical. It's asymmetrical.

So, let's get into the model and my proposed levels of risk. I've created this very basic illustration of the model, which will help me explain it, so I'll put that up on screen.

Now, what I'm suggesting here is that there are four logical levels of risk. We know that crypto investing is already a high-risk asset class, but I'm not coming from the perspective of a general investor here. I'm starting with — and staying within — the realm of crypto.

I'd say that Bitcoin is the reserve asset in crypto. You may personally measure your returns from dollars to dollars, but many seasoned crypto investors measure their returns from Bitcoin to Bitcoin. And this is because it's based on the premise that Bitcoin will expand from being the crypto reserve assets to being the global reserve asset, eventually. So, from that point of view, it makes more sense to accumulate BTC than USD.

But that, of course, is a personal preference. If we say that Bitcoin is the reserve asset, that effectively makes it cash, putting it at the risk level of zero — no gain, no loss, just preservation of purchasing power. And that's due to Bitcoin's limited supply. If you own 210,000 BTC, then you will always have 1% of the BTC supply.

Not so with fiat currency, because fiat currency is elastic money. Your share of the whole changes over time based on the central bank's creation or destruction of the currency supply.

So, with that, now let's say we want to invest to make more Bitcoin. We then progress to risk level one, which, in my illustration here, [are] base layer, smart-contract platforms like Ethereum and Cosmos (ATOM, Tech/Adoption Grade “C+”). I want to say base layer — they are networks that you can either build apps on, but they're also networks that you can build all the networks on.

Before we go there though, let's make sure we've established risk level one. So, I have zero risk if I sit in Bitcoin as cash. And if I trade some of that for a level one risk asset, like Ethereum or Cosmos, the risk that I am taking is that I get less BTC back when I sell it. That's the risk I'm taking by going into risk level one.

The intention, however, is to get back more BTC than I invested. So, I want to invest in an asset that outperforms Bitcoin, which is basically outperforming cash in this case.

So, I'll say that again: The reason many crypto investors choose to measure their wealth in BTC is because it's the only objective measurement of wealth. Unless you have something that is absolutely scarce, how do you know if you're accumulating or losing wealth? That's why, when I give examples, I say things like, "If you own 1% of the Bitcoin supply, you will always own 1% of the Bitcoin supply." It's a totally objective measure.

If you go from 1% of the Bitcoin supply in your possession to 1.1% of the Bitcoin supply in your possession, then you know your wealth has increased. By contrast, if you own 1% of the dollar supply, and then you increase that to 1.1%, well, that doesn't tell you much, does it? You need to do another calculation on top of that to figure out if your net purchasing power has increased or decreased. So never mind that.

Back to the model, I left off there saying that Ethereum and Cosmos were these base layer networks that can be used as platforms to build apps on or as platforms to build other networks on. And this takes Cosmos as an example here. THORChain (RUNE, Tech/Adoption Grade “C”), and what's the other one … Terra (LUNA, Tech/Adoption Grade “D”) blockchains … they are networks that are built on Cosmos. Now, Cosmos has its own token: ATOM.

So, in my model — here, I'll put it back on screen again. The ATOM token would be on risk level one. It's one "step" away from Bitcoin. Then, we have THORChain with its own native token, RUNE, and Terra with its native token, LUNA. Since these are built on a network that is already a risk level one, well, I would consider these risk level two since they are two steps away from a Bitcoin.

Now, the same goes for Polygon (MATIC, Tech/Adoption Grade “B”). I consider this also to be a level-two risk asset since it's built on a level-one risk asset, Ethereum. Now, I'll come back to Uniswap (UNI, Tech/Adoption Grade “B”) in a moment. So, expanding beyond Polygon, there are specific apps built on that platform form, like QuickSwap (QUICK, Unrated) or Sunflower Farm (SFF, Unrated) in my illustration. They get labeled as risk level three because they're built on top of risk level two.

And then, finally, I'm considering that there's a fourth risk level here, which would be anything built on a risk level three. If Sunflower Farm is a risk level three, then in-game non-fungible token (NFT) items are even further out. And those are the ones that I would consider risk level four.

And I suppose that's where we should stop with the model. I mean, that's as far out as we need to go, really. NFTs [are] inside of apps or games that are built on networks that are built on networks. This is how far out we're going here.

Now, it'd be no surprise to you that the age and the market cap of an asset has a lot to do with it being on which logical level of risk. Almost all crypto assets start out as micro caps, like Sunflower Farm — tiny, tiny market caps.

Now, I was going to say that as they grow, they go down the risk levels, but I'm not sure that's the case. Sunflower Farm, again, if [the] Sunflower Farms app game grows well, it's still adding value to the underlying network, which is Polygon, but it doesn't change its position in the hierarchy. Polygon is still a safer investment since its risk is spread much wider.

And what I mean by that is demand for the Polygon network can come from any of a thousand apps that are deployed on it ... while Sunflower Farm is a game, which means it has to succeed on its own, perhaps with the help of its community. And I was going to say that you can't invest in a community, but since a token is at the center of a given ecosystem … well, investing in that token is very much buying a stake in that community as well.

I suppose that's the difference between equities and tokens. With tokens, you've got the power and the incentive to participate, whereas it's not so direct in equities, even if you do have voting rights and whatnot.

So, this is the basic model. The only other thing that needs pairing with this model — knowing which logical level of risk you’re on — is a strategy. And I've got a really easy one for you to bundle with this: The strategy is simply reduce the size of your exposure as you go up the levels.

I'll use an extreme example to illustrate this. I've been using this Sunflower Farm as an example here. So, this happens to be a brand-new game that launched on Polygon just one week ago. It took off really quickly, and it was growing really, really fast. But because there was next to no price history and no data on it whatsoever — other than a week's worth — and because it was already on risk level three, I decided to be extremely cautious when investing in it.

So, what did I do?

Well, the token was trading at a $1.02, so I bought $50 worth. And then, the next day, the token price dropped 25% to 75 cents, so I bought another $50. Why such small positions? Well, because that was a direct reflection of the level of risk that I deemed that I was taking. I could just have easily gone ... or the token, rather, could have just easily have gone from $1 to $10 in the following seven days.

So that kind of volatility requires such caution. And that actually links back to what I said earlier about risk and market cap. Such volatility as this, like 25% of the day, is to be expected when your asset is new and it has a tiny market cap.

Should you invest in such things is the question.

Well, my job is not really to say either way. My job here, especially with this model, is to help you get a clearer picture of what you're dealing with so you can make informed decisions.

So let me know what you think to this model, using my logical levels of risk. You can do that by either tweeting at me — it's @ChrisConeyINT — or write to me on the Weiss Website here, if you're able to do that.

But that's going to do it for this week's edition of the Weiss Crypto Sunday Special. Keep a close eye on your inbox for next week's episode. But until then, it's me, Chris Coney, saying bye for now.

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