Crypto Risk Capital and Allocation

Digital asset markets are highly unpredictable, and you cannot account for every risk factor that comes your way. A project could appear perfect, but what happens if a founder dies before the project is off the ground? You may never see your money again.

Risk Capital

Before you spend a dime on a cryptocurrency or NFT, determine how much money you are willing to lose. That sum should not include capital necessary for your lifestyle (bills, leisure activity, etc.). What’s left over is the capital you are trying to build through investing.

  • Cryptography – A study of secure communications techniques in an adversarial environment
  • MetadataData that describes some other data. Ex. the caption describing an image
  • WhitepaperInformation document used to promote or highlight the features of a solution to a problem, product, or service

How do you figure out your risk capital?

First, calculate your monthly expenses—rent, food, car payments, insurance, personal hygiene, packs of cigarettes, going out, etc. Then include the money you put towards your emergency fund. 

The rule for emergency expenses is that you should be able to lose your job but still have enough to pay all of your bills for at least six months. You would not want to sell out of a lucrative investment because you need to make ends meet. 

Whatever money is not a part of your expenses or emergency fund, we will consider it as risk capital.

What if I don’t have any excess money?

If you find yourself without money to invest at the end of the month, either cut back on lifestyle costs or grow your income. Your expenses will wipe out your investment portfolio if you cannot do this. Never mind any other risk factors that come with investing.

Cut Spending

The quickest way to free up cash is to better manage your spending. Some commonly overlooked sources of money sinks include:

  • Subscriptions (gaming, video streaming, software, unused gym membership)
  • Nightlife (drinks, food, transportation, cover prices)
  • High auto insurance  (shop around for better quotes)
  • High health insurance (shop around for better coverage)
  • Buying home necessities from an expensive supermarket
  • High taxes and unused credits

Increase Income

If you cannot change your expenditures, build up your income. 

If you have a job, plead your case and negotiate a pay raise. See if you are approved for overtime pay or work toward that performance bonus. 

If you work for yourself, figure out ways to increase revenue. That could come from automating your recurring tasks to free up your time. That way, you can focus on making your products or services better, more efficient to deliver, and getting in front of more potential customers. 

If you want to work for yourself, figure out what you can do now to benefit someone immediately. If you can do anything to make someone’s life easier, you can profit from it. You could:

  • Cut grass
  • Style hair
  • Create websites for small businesses
  • Do handiwork
  • Sell arts and crafts
  • Sell your fishing secrets for the town you live in
  • Walk dogs
  • Sit houses
  • Help promote local businesses
  • Write blogs for companies
  • Teach people how to take selfies
  • Lead yoga sessions and much more 

The idea is the more free cash flow you can generate early on, the more risk you can handle, and the faster you can begin to grow your wealth through crypto investing.

Pro Tip: Delegate your work to grow your business. Teach someone how to do your job and pay them to do it, or hire someone with the skills. Leave the business profit to grow by charging an appropriate rate for your service or product. Use your free time to serve more people.

Allocation Strategy

After defining your risk capital, you need to determine how you plan to divide the pool of funds. How much money you allocate toward different projects impacts your potential returns and portfolio risk.

Portfolio Structure

From earlier lessons, we concluded that there are many different types of crypto assets. We prefer a balanced approach to structuring our portfolio holdings. 

Our asset mix includes the following:

  • 30% stablecoins
  • 50% large-cap projects
  • 20% small-cap projects

Building our portfolio this way allows us to capture volatile moves to the upside while minimizing our downside risk. It also allows us to deploy capital when crypto prices are down overall.

Stablecoins

These tokens represent currency that we are used to transacting every day. Stablecoins like USDT and USDC are digital representations of the US dollar. 

The price of these tokens should never de-peg from the currency it represents (although it does happen). Investors and traders use stablecoins to store profit and decrease portfolio volatility without leaving the crypto space. Without stablecoins, investors would have to sell their holdings on a centralized exchange for fiat.

Large-cap Crypto Projects

Due to their level of decentralization, leading crypto projects like Bitcoin and Ethereum are considered less risky than other projects. The larger and more decentralized the project, the harder it is for a few players to manipulate the price of the assets in either direction. 

However, the decrease in risk also means that the potential returns from price volatility are limited. It would require much more capital for a billion-dollar project to do 2x than an altcoin with a million-dollar market cap.

Small-cap Crypto Projects

What market capitalization makes a crypto project a small cap is debatable. We consider anything below $100mm small and extremely risky. 

These plays allow for the highest risk-to-reward ratio in a bull market. However, without thorough due diligence and a well-established profit-taking strategy, it is difficult to succeed in investing in these projects. 

Small-caps often trend to $0 during a bear market as the companies behind the projects become insolvent. The decrease in overall demand for crypto also leads to rapid price declines for these tokens, as they are often the first to be sold for fiat, stablecoins, or large-caps.     

Portfolio Concentration vs. Diversification

Outside of having a specific percentage of your portfolio dedicated to stablecoins, small-cap, and large-cap coins, it is necessary to determine how many projects you want in the portfolio. 

Depending on the starting amount of risk capital, too many projects could lead to dismal returns, even if one of the projects appreciates a significant amount. Conversely, having a large amount of money in one project could cause your entire portfolio to tank if the project turns out to be a scam or fail.  

Holding around 4-6 different projects at a time may be a good starting point. One would be a stablecoin (USDC), 1-2 large-caps (BTC/ETH), and 2-3 high-conviction small-caps.

Next Steps

If you feel prepared, take our Introduction to Bitcoin and Blockchain quiz:

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