Risk management frameworks are an integral component of ensuring your business runs at peak performance. You should create one tailored specifically to your needs that can also cross-reference leading reference frameworks.
Current information gaps prevent many countries from being able to accurately assess crypto risks. In this paper, a methodology is proposed that operationalizes such risks within C-RAM assessments.
Risk Tolerance
Cryptocurrencies are highly speculative investments with variable and heavy-tailed returns, creating unique challenges to risk evaluation and management. When evaluating a cryptocurrency’s risk it is necessary to take both market movements as well as its fundamentals into consideration when making your evaluation.
This includes its core technology, development team and use cases. Furthermore, cryptocurrency’s stability and security are critical elements to its long-term success. Furthermore, understanding how to mitigate counterparty risk in the cryptocurrency marketplace is vitally important as well.
At an organization level, it’s essential to determine its tolerance for risk and to align its risk treatment plans with its risk capacity. Someone investing with a 30-year investment horizon may have greater tolerance for risk than an investor looking for early retirement within one year. Therefore, continuous monitoring of risk tolerance to identify any gaps that require attention should occur as well as considering any impact cryptocurrency prices may have on overall financial goals and goals should occur simultaneously.
Position Sizing
when investing in crypto assets, traders should carefully consider the size of each trade they make. This determines how much of their portfolio could be at stake should a loss occur and should correspond with risk management objectives.
Cryptocurrency prices could impose significant fiscal costs on the external sector, particularly financial institutions and state-owned enterprises (SOEs). One source of such cost may come in the form of banks’ increasing holdings of cryptocurrency holdings to cover credit exposure to crypto issuers; price volatility could also cause losses for other financial intermediaries through remittances and capital flows.
Participants’ evaluations of inherent risk ranked effective exchange controls over transactions as the biggest threat, followed by market manipulation and difficulty establishing coin value (Deloitte 2021). It is critical that investors carefully evaluate the security, reputation and protocols of a crypto trading platform before depositing funds or investing.
Investing in Cryptocurrency
Cryptocurrency markets can be unpredictable, subject to short-term speculative trading and price movements that often ebb and flow rapidly. Furthermore, as they’re still relatively new assets classes without sufficient regulations to safeguard investors against fraud or manipulation schemes.
Users often rely on third parties, like exchanges and custodians, to trade or store cryptocurrency. Unfortunately, such third parties are susceptible to security breaches, insolvency and mismanagement – creating significant counterparty risk. Furthermore, smart contracts (autonomous agreements executed via blockchain technology) may contain errors and vulnerabilities (Reiff 2019).
Loss of access to funds on the blockchain is highly likely and immensely impactful; yet its actual effects can be hard to assess. Furthermore, inherent risk judgments correlate negatively with cryptocurrency experience: professionals with prior experience tend to rate inherent risk lower.
Monitoring Cryptocurrency
Cryptocurrency transactions are digital, using public/private key encryption to secure their data. This makes cryptocurrency less vulnerable to theft, fraud and phishing attempts than traditional financial transactions; however, this doesn’t completely mitigate cyberattack risks on platforms or users.
Counterparty risk poses a formidable challenge to cryptocurrency companies and users, given its decentralized nature and lack of legal frameworks to regulate them. Without an established legal framework in place for regulation purposes, it may be hard to identify, assess and mitigate these risks effectively.
Monitoring is an integral element of cryptocurrency risk management, and should include the establishment of clear reporting standards and procedures for suspicious transactions, automating their analysis and flagging as high-risk, as well as using advanced analytics and machine learning techniques to detect patterns that indicate money laundering or terrorist financing.
An effective transaction monitoring system can assist businesses in detecting and preventing money laundering, terrorist financing and other forms of illegal activity. Such an analysis should utilize both on-chain and off-chain data sources – including mixer detection, clustering of addresses associated with one entity and risk analysis – as well as off-chain information like mixer detection.