Crystal Clear Educational Series 5: Risk Management & Appetite 😏
Learn the ins and outs of the risks in DeFi
Knowing Your Risks
As a new investor to DeFi, or maybe even a relatively experienced one, it is vital to understand the risks involved with your investments. In this article you will learn about a couple of DeFi risks.
Risk is an important part of your portfolio, and understanding the inherent uncertainties of investing in a DeFi project is vital to ensure that you have a positive and profitable experience. None of this is by any means financial advice, but it should empower you to make more educated decisions about your portfolio. We will outline some of the risks associated with DeFi below:
The Big One: Rug Pull
The biggest risk of interacting with smart contracts as far as a total loss perspective goes is most definitely the “Rug Pull”. It’s the one we all know and hate and it is about as old as cryptocurrency as a whole. There are multiple ways in which a development team may “rug”, but usually it involves a large upswing in price and a removal of liquidity, leaving investors with useless, untradable tokens, and devs with a big stack of tokens that are valuable such as $MATIC, $BNB or $ETH depending on the liquidity pool.
One should always err on the side of caution with new anonymous DeFi projects that pop up out of the blue promising massive returns on investment, especially with an elusive or uninvolved core team.
There are auditing companies that also take a look at the source code for smart contracts and deliver a report for investors that highlights any potential security flaws in the code itself. There are also plenty of tokens who pass audits who still fall victim to exploitation, please do not use an audit as a hard and fast rule that a project is safe.
Doing proper research, reading documents and understanding the basics of projects and looking for audits, community engagement and other green flags can lead to a nice profit, but newer projects are inherently more risky, always do your own research, and don’t get caught up in FOMO!
Given the age of the DeFi space, and that we are still in the “dial-up” days of decentralized finance, there is a large degree of speculation that happens on new projects. This usually leads to a massive upswing in price, and an equally large drop or dump at the start of a tokens life cycle. It is important to know that most new tokens experience a lot of volatility in the early stages as liquidity can be quite low, which causes large transactions to have a very noticeable effect on price.
It is very easy to get caught up in the “Big green candle, stonks only up” mentality, but this is a dangerous one. With any DeFi or other crypto purchase, if you wish to perform speculative investment (buying low, selling high) ensure you understand the tokenomics of the token you are purchasing, as it is easy to get burned if you do not understand the protocol.
Given the volatile nature of most cryptocurrencies (with the exception of some stablecoins like $DAI and $USDC), they are subject to a constant change in value. Due to the fact that one must contribute equal values of token A and B, what happens if one or both of those tokens change prices? The AMM will automatically swap one asset for the other to ensure an equal pairing. What does this mean for you as an investor? Let’s say you put in $50 dollars of token A and $50 of Token B, and A has a price of $2 per token, and B is $1, you would have contributed 25 A and 50 B. Lets say the value of B jumps up to $2 per token, and A stays at the same price, and you go to withdraw liquidity. You’d quickly realize that you now have less of token B and more token A. If liquidity is withdrawn at this pricing, you’d have incurred roughly a 6 percent loss when compared to if you just held token B instead of contributing to the LP. This is a pretty extreme example, though.
Given the inherent risks of interacting with DeFi projects, it is vital that you understand your own risk appetite. There is no easy way to calculate this, but the general advice of anyone in the DeFi space is that one should never risk money they cannot afford to lose, and ensure that they have the proper expectations set based on each individual project they interact with. This final tenet is key, as low risk usually means low reward and are more safe, and high risk investments can have huge payoffs, but can be dangerous.
No One Can Tell You What You Should or Should Not Invest
Telegram/Discord groups are good fun, and people love a good buy the dip meme, but it is so vital that as an investor you adhere to your own discipline and appetite for risk.
What products are available on PolyCrystal to the varying degrees of risk appetite?
PolyCrystal has a wide array of financial products, from Farms for earning from LP tokens, staking pools to earn $CRYSTL, and also to earn other tokens and major cryptocurrencies such as $BTC, $ETH, $BNB, and $USDT! This creates a wide variety of chains and loops that you can perform that cater to all sorts of appetites. I’ll provide an example for a low, medium, and high risk appetite investor. As stated above, this is not financial advice, and these are not hard and fast rules, but simply guidelines or ideas for how you may choose to set up your portfolio based on risk
Low Risk appetite
If you wish to gain exposure to PolyCrystal because you wish to use your $CRYSTL to stake for a non-native like $USDC, one may choose to create a stablecoin pairing and stake those LP tokens to earn $CRYSTL, and take their earnings and stake those earnings in the $USDC pool. With this method, you have no exposure to the price action of $CRYSTL, as you earned it through staking an LP token which has very little if any variation in value, but you still get to enjoy earning the token and staking it for another stablecoin which also does not vary in value. The rewards with this method will not be life changing, but you have little to no exposure to price fluctuations, except in that they affect your overall earning potential.
Medium Risk appetite
If you wish to have some hard and fast earnings, but don’t want to go full degen mode, one could create LP tokens with a mature token (like $ETH, $MATIC, $WBTC and so on) with a stable coin. These farms have higher APRs usually (definitely subject to change and there are exceptions to all rules) than stable/stable LPs, which serve to print more $CRYSTL for you to invest. The risks here are that you could be subject to impermanent loss if there are significant changes in the price of $ETH while you have staked your LP tokens.
High Risk appetite
For someone with a higher than normal risk appetite, one could stake a variable/variable LP pairing ($ETH/$BANANA, $JDI/$MATIC etc, keep in mind that the less established projects tend to carry a significantly higher degree of price volatility, and in turn, risk) as these farms print $CRYSTL at a significantly higher rate. This allows you to earn more $CRYSTL for staking, but you are more exposed to significant price changes in both sides of the LP pairing!
This is just a brief overlook of risk appetite, it is an impossible topic to truly teach upon, as everyone is their own person, but given the wide array of services out there, this should give you a little more insight into what is considered “More Risky” and what is considered “Less Risky” when it comes to setting up your portfolio.
The important thing to remember is at the end of the day your funds are your own! You may choose to do with them what you please. Nobody enjoys losing money, especially when it is money that you couldn’t afford to move. DeFi is an incredible space to begin taking control over your own assets, but please bear in mind that no one will ever provide you with financial advice (this article included, always do your own research, read docs, and make informed decisions). If you ever have any questions about our different products, our telegram community is extremely active and enjoys sharing different strategies and having open discussions about ways to use the protocol.
Happy investing, and BE SAFE!
PolyCrystal Telegram: https://t.me/polycrystalfin
PolyCrystal Website: https://polycrystal.finance/
This article was written by King D
Telegram Handle: @King_D3