Risk management by definition is the process of identifying, analyzing and mitigating the possibility of losses on an investment. When trading on behalf of investors, most companies hedge their positions to protect the value ‘at risk’. This means that they cover the value of the original amount invested to protect it from price volatility or market risk during the time period of the trade or investment.
Over the last two years, in DeFi, many platforms learned the hard way that compliance and risk management matter, and not only for regulators or in banking. We have seen many platforms crash and burn because they did not take into account market or price risks on strategies they were invested in; nor did they adequately cover risks that third parties, trading on their behalf, were taking.
Celsius Networks is a great example of not managing your value at risk until it is too late. During the good times, as their funds under management grew in value and they diversified their lending portfolio, their lack of risk management was not really a problem as they could always borrow against their custodial holdings to fund further projects or to meet client withdrawals.
However, after the Terra Luna meltdown and the ensuing crypto market crash, their exposure to losses began to add up and they could not meet their obligations as a lender to their clients, or to creditors and partners such as KeyFi and BlockFi. Celsius’ lack of hedging or risk management was their downfall.
Executing trading strategies without proper risk management IS a disaster waiting to happen. Whether we are in a bear or bull market, you can’t anticipate every outcome; so you have to protect the principal using proven risk management strategies.
Both BlockFi and Celsius learned the hard way that although you make a ton of money on the upside using leverage, you also cannot cover your losses on the way down. Let’s explain. Celsius networks was a cryptocurrency lending platform; in many ways they were like a savings account but with an amazing APY.
Celsium allowed their customers to lend their cryptocurrency to them and earn income from it (APY) or they could take a cash loan on their cryptocurrency without having to sell it. Either way, Celsius (as the custodian) used these assets as collateral to secure loans, which they used in many different strategies to generate their amazing APY on your investment (this was their trading strategy). It also turns out they loaned customer’s crypto to third parties as well without managing these risks either!
By taking out loans on custodial collateral, they leveraged their positions. Leverage increases your return on the upside but also increases the amount of risk you are taking. Instead of having to meet their obligations for customers only, they also had to come up with the capital to meet their loan obligations for strategies they funded using the loans on their customer’s deposits.
Directional strategies are built around the market moving up or down in one direction. Many of their directional strategies were built around the value of custodial assets continuing to increase. Obviously, this combined with the additional leverage in loans, meant that when the market crashed, there was no way to recover what they had lost even with their custodial assets.
What BlockFi and Celsius have taught us is that trading strategies without proper risk management are a disaster waiting to happen. You can’t anticipate everything; so you have to protect your principal and diversify your investments. Even in crypto winter and a bear market you need to be prepared. At Rand this means being delta neutral.
Delta-neutral trading strategies simply mean that you cover the principal at risk by trading the other side to mitigate any price/market volatility risk. This protects the principal invested, but you can still benefit from the upside on the original trade. This is a common risk management strategy used by banks and in trade finance.
Our investment manager, Felix and his team, are constantly building and testing our investment strategies to assess their ability to withstand price and market volatility as well as the returns they can generate. Keeping your money safe while invested is our number one priority.
At Rand, we have a vision of building a world where everyone has access to smart financial tools that improve their quality of life — regardless of income or knowledge. We want to help you grow your money 50x faster.