What exactly are the risks in the crypto world? Why is the crypto industry considered the riskiest?

Why Risk Comes First?

Today I want to discuss the concept of risk in investing. Some people might find it boring or uninteresting, not as exciting as making money. Although everyone agrees that risk is important, many are simply not interested in it.

In fact, emphasizing “Risk First” in investing makes sense. Investing is not a short-term activity but a long-term process. It’s like a marathon race; during the long run, unexpected events can happen, and excessive damage must be avoided, or else you will lose the race.

Investing is very similar to warfare. Even the greatest generals will have failures. While generals can win countless battles, losing the war on the 101st attempt means death on the battlefield. This is like the crypto and stock markets: if you lose your principal, no matter how skilled you are, it’s useless. Xiang Yu was undefeated in many battles but ultimately lost at the Battle of Gaixia and committed suicide by the river; Liu Bang often lost in battles but always planned his escape and risk control, eventually unifying China. Therefore, every battle is crucial.

Before battle, generals conduct strategic analysis, assess possible scenarios, and prepare contingency plans. Since they don’t know if they will win, risk control is the top priority. As Sun Tzu said: “First, position yourself in a place where you cannot be defeated; then victory depends on the enemy’s flaws.” In the crypto and stock markets, whether you make money depends on the market’s stupidity.

Zhuge Liang was a cautious and conservative person, but he had to take huge risks to use the Empty City Strategy. Clearly, Zhuge Liang was very lucky. If the strategy had failed, his reputation would have been ruined. In other words, his lifetime reputation almost was lost because of that risk. Sima Yi, on the other hand, was always cautious, adopting a conservative risk control strategy, and had already planned how to escape before battles.

Investing is like a coin with two sides: returns and risks, which are interdependent. People often say high risk, high return, but this is vague and not entirely accurate. High returns naturally come with high risks. If there were opportunities with high returns and low risks, everyone would rush in, pushing prices up and reducing actual returns. Therefore, low-risk, high-return products are almost nonexistent in the market.

On the other hand, does high risk necessarily lead to high returns? Not necessarily. Many junk coins and concept stocks are extremely risky but do not generate high returns; they are low-probability events. So, high risk does not always mean high reward. However, high-return investments usually come with high risks, and the relationship is unidirectional, not necessarily connected.

Investing is essentially like doing business. The profit is income, and the risk is cost. If you don’t control costs in business, no matter how good the business is, you may end up losing money. In investing, identifying and managing risks is very important. Cost control and profit estimation from business are applicable to investing. Before making a deal, you should do thorough calculations, assess risks, probabilities, and odds. Only after detailed analysis can you decide whether an investment is worthwhile.

Wealth growth mainly relies on compound interest, with the second parameter in the compound interest formula being the annual return rate. The annual return rate in investing has an upper limit. Buffett’s long-term average annual return is about 20%. Overly pursuing high-return products can bring unnecessary risks, leading to principal loss and ultimately lowering the actual return rate. Therefore, don’t chase high returns excessively. For most people, exceeding 15% return requires caution and a deep understanding of value investing.

Actual returns are the product of expected returns and risk. For example, suppose you have 1 million yuan and face two options. The first: invest and lose 50% in the first year, leaving 500,000; then gain 50%, reaching 750,000; and another 50% gain in the third year, ending with about 1.125 million. Over three years, the seemingly high return results in an annualized return of only 11%. The second option is a relatively conservative 25% annual return. After three years, your assets nearly double.

Choosing high-return strategies means that 1 million yuan only grows to about 1.12 million in three years, almost the same as the original principal, wasting three years. Conversely, a more conservative approach can lead to steady wealth growth. Excessive pursuit of high returns can cause deep loss of principal and waste time, making compound growth fail.

Deep loss of principal is the number one enemy of compound investing, and such loss is caused by high risk. That’s why risk comes first. Buffett has repeatedly said: “Never suffer permanent loss of capital; this is the first principle. The second principle is to never forget the first.”

From another perspective, risk first means that opportunities in the market are unlimited and always present, but your capital is limited. When you use limited funds to gamble on unlimited opportunities and risks, mistakes are inevitable. Therefore, controlling risk is paramount in investing.

In the crypto and stock markets, how much you can earn depends on market madness and the future performance of companies, which are beyond our control. The only thing we can do is control risk—“do your best, leave the rest to fate.” Risk control is a necessary condition for success in investing. While controlling risk doesn’t guarantee profit, failing to control risk guarantees failure.

Conservative valuation, position sizing, and price levels help us control risk; thus, conservatism is very important in investing. By controlling risk and limiting downside, we can stay invincible and wait for the market to make mistakes, thus achieving profit.

What exactly is risk?

Today I want to elaborate on the topic of risk, including its essence, types, magnitude, and how to handle it in investing. The goal is to help everyone understand and respond to risk correctly in daily life and investing, avoiding traps and common mistakes.

First, I want to correct a common misconception in the market—that volatility equals risk. In fact, volatility is not risk. Whether short-term or long-term, volatility is a normal market phenomenon. It’s like atomic vibrations—normal and expected. For investors, volatility is just the fluctuation of prices in the crypto and stock markets; it doesn’t cause real loss. However, if you engage in short-term trading, frequently buying and selling at peaks and troughs, then volatility becomes your risk. Short-term trading introduces unnecessary risk and reduces returns, which is why I do not advocate short-term trading.

Although the market offers many opportunities in the short term, capturing them requires the ability to predict market movements. But as previously mentioned, technical analysis is useless. Short-term opportunities are small, and risks are uncontrollable. Therefore, in the long run, short-term trading is often unprofitable. This explains why many companies, so-called experts, and influencers sell various technical indicators. If these indicators truly made money, they would use them themselves rather than sell them. This is common sense; we should not make such basic mistakes. Throughout history, no one has achieved long-term stable profits through short-term trading.

Regarding volatility, the basic attitude should be to prevent it from becoming our risk. We should extend the time horizon to bridge short-term fluctuations. Like fishermen understanding the height and wavelength of waves at sea, if the boat is long enough, it can cross two wave crests without capsizing. This strategy involves extending the operation cycle to cope with market fluctuations and avoid risks caused by volatility. Overall, volatility itself is not risk; perceiving it as risk is a result of short-term trading behavior.

The essence of risk is very similar to uncertainty; they are almost synonyms. Uncertainty refers to our lack of understanding or subjective belief that certain events won’t happen, but in reality, they do. Therefore, the essence of risk is the things we cannot predict, which we think won’t happen but eventually do.

From an investment perspective, risks can be roughly divided into three sources: first, operational risk of the enterprise, including industry cycles, consumer demand, competitiveness, management, corporate culture, branding, and technology. Any change in these factors can bring risk, ultimately reflected in reduced profits or profit margins; second, market risk—the fluctuation of crypto and stock prices. In a bull market, due to overly optimistic sentiment, prices can be driven very high; in a bear market, due to pessimism, prices can fall very low. When market sentiment shifts, it causes prices to be irrational. This risk stems from market irrationality; third, investor’s own risk, including lack of ability, poor position management, and irrational emotions.

Among these three, the investor’s own risk is the most important. Most significant losses come from the investor himself. Compared to operational and market risks, personal risk accounts for 60-70%. Fortunately, this is within our control. As long as we control our emotions and human nature, focus on our circle of competence, we can avoid self-inflicted risks. Operational risks can be assessed from various angles. Market risk may be the least important, as it’s a source of uncertainty, but we can overcome it. Market risk is like volatility; we can use the cyclical nature of bull and bear markets—buying during bear markets and selling at higher points.

From a trading perspective, there are mainly two risks: one is missing the entry point, leading to missed opportunities, which is relatively minor. Our funds are limited, and opportunities are unlimited; missing them doesn’t cause loss of principal. The other is buying at a high point, causing capital loss, which is more serious. Whether prices will rebound depends on your understanding of the company and your trading accuracy. Even if you recover from a loss, it wastes a lot of time. In compound investing, time is the most critical factor.

The risk of losing capital is greater than the risk of missing opportunities. Therefore, our attitude toward these risks differs. When market opportunities are unlimited, missing out is not scary; losing principal is. Invest only when you are confident. Even if others recommend something, if it doesn’t suit you, just give up. Like a baseball player, don’t swing at every pitch; only swing when you have confidence. Our attitude toward risk is conservative—better to miss 1,000 crypto opportunities than to make a wrong investment.

People should recognize their limitations and learn to give up. Don’t do things beyond your circle of competence. We only need to wait patiently, earn what we deserve, and not chase every opportunity. Most billionaires have built their wealth through one or two companies. We don’t need to bet on every opportunity; just wait for the “rabbit” within reach. It’s a metaphor—what matters is not always trying to catch all opportunities.

Greed is human nature; we should control it and focus on our circle of competence. Focus means giving up other things and concentrating on one area. We also need patience, waiting for opportunities because markets are unpredictable; we can only wait for opportunities to appear. When they do, confidence comes from our circle of competence, enabling us to buy.

Finally, how do we measure risk (what is the scale of risk)? The main measure is based on the probability of occurrence and the odds after occurrence. In life, we are often driven by desire and find it hard to rationally assess true risk. For example, some people like to buy lottery tickets. Although the odds are high, the probability of winning is very low. I notice that most lottery buyers are poor—they desire wealth, which is fine, but without calculating the risk, it’s like throwing money into water. They only see the high payout but ignore the very low chance of winning. “Poverty is a disease,” which depends entirely on one’s mindset. Desire drives people, making it hard to see the truth.

Another misconception about probability and odds: some people like to run red lights or speed. Although the probability of accidents from these behaviors is small, the consequences are severe, and the odds are terrible. People often underestimate the seriousness of such behaviors, thinking the chance of an accident is low, but if they keep running red lights, accidents will happen eventually. Repeating this behavior over decades accumulates a large number of violations, increasing the probability of accidents, which can be fatal.

Therefore, bad behaviors tend to lead to bad outcomes. Some people experience misfortune throughout their lives; it may seem accidental but could be inevitable. Hence, “a pitiful person must have faults,” which is closely related to one’s mindset.