There is a lot of excitement over the current state of the market. Its easy to get carried away with the hype. Most people in the crypto space tend to focus their attention on trading, since that is what they hear about most, and it works when the market is in a bull run. But I believe that there is a better way to earn good returns during all market cycles. with less risk involved. I want to talk about some of the strategies that I have found to be helpful to manage Defi risk.
Learn about the Defi space
Some people can learn themselves, but you can benefit a lot from a good course. Its getting more and more costly to experiment and get practise since the network fees are so high. Investing in this space is very different than the traditional financial systems, and the economics are really different. Some of the basic rules might apply, but many of them don't. The current user interfaces can be unforgiving, and mistakes can be costly. Here is the Learnyearn site from the yearn.finance documentation, as an example of good docs:
Reduce risk with Stablecoins
A good investment is the ycurve vault on yearn.finance. They make it simple to use and get the best returns without the volatility risk. They further reduce the risk of individual stable coins (algorythmic or collateralized) by using a basket of 4 different stablecoins. Another pool which does this is the y.curve.fi pool on curve, or musd on mstable.org. That way you are not depending on any individual stablecoin to maintain its peg in the event of a disaster. The yearn project also allows you to invest in BTC, which is probably the least risky crypto currency. For that, the best, and easiest choice is the sbtc pool on yearn.finance vaults. You can earn also very good returns while hodling Eth, which is relatively safe, certainly compared to ERC20 coins.
Diversify your portfolio
Don't put all your eggs in one basket, and don't bet the farm on 1 project. Don't place large bets on individual positions. Spread out the risk. That way there is a lower chance of a downturn affecting all of your investments. Don't put all your faith in technical analysis. There are lots of different factors that can affect the price. You can also hedge high risk positions with "put options", which will protect you on the downside.
Minimise short term trading
You can't predict the future, especially in the short term. So, why try to time the market when there are other strategies and aggregation projects that can earn very good rewards without doing a lot of trading. Also, the gas fees are becoming prohibitive for this type of activity. You may end up paying more in fees than you are earning in profit, unless you are trading with very large amounts, which is also high risk. Take a long term view, and look at the big picture.
Read whitepapers. There are lots of places to get detailed information about projects. If you can't find any documentation, that is a red flag. Chose projects with sustainable value, and good Price/Earnings ratios (see token terminal). Do your due diligence.
Don't FOMO into projects that are shooting up in price
Only exception is when you feel that they have long term value, and you are prepared to stick with them if they drop. Also look at other tokenomics like market cap, circulating supply, how many coins are being issued and to who etc.
Look for projects that are audited, and have a track record.
This is a great site to check DEFI projects that have been audited. You can see their overall safety/security score, and drill down to more detail, and even the audit report itself, which you can read. Be sceptical of marketing hype and overly ambitious claims that are not backed by evidence, and solid fundamentals. The projects should have a good team, sensible roadmap, community, support resources etc. Avoid projects with anonymous teams. To me, that is a big red flag.
Look for projects that have a working version, or at least a prototype to test. Check out the user interface by using the product with small amounts.
Look into coverage for things like smart contract bugs, hacks, liquidity events etc. There are good products from Nexus mutual, put options from Opyn, and also coverage from insure.finance. You can also sell insurance on some of these platforms, which could be a good investment.
Don't risk more than 5% of your overall portfolio, especially if you are close to retirement
Start off with smaller amounts. That way you don't have as much to lose, as you gain experience. You are dealing with real money. Things can go wrong, and you have to be prepared to handle them. The ethereum network doesn't scale enough yet, and there will be bugs.
Stay away from leverage and shorting
These are advanced technique which should only be used by experienced traders, with caution. If you do, you have to monitor them closely or face costly liquidations.
Use Yield aggregators to batch transactions and strategy and save on gas costs
See this article for more detailed explanation of alternatives. Use the wisdom of the crowd and the experts, and economise on network fees.
Realise that current high Yield farming gains are not sustainable in the long term
Its ok to indulge in high reward activities only if you know what you are doing and understand the risks. Earn the governance tokens, don't buy them to speculate. If you get them for free (or providing liquidity) you don't have a lot to lose. Also recognise that liquidity mining has to be monitored more closely since it can change quickly. Also, remember to claim your rewards on a regular basis if you are using farming, or staking. You might miss out on rewards if they are time limited. If you are a liquidity provider, avoid strategies which could result in "impermanent losses".
Dollar cost average on the way up, and Take profits along the way down
Slowly add to your position if you think the price is going up, with smaller amounts on a periodic basis. Sell your original investment or a percentage if you make a big gain.
Especially if you are using multiple wallets, you might forget about some of your investments. And some of the more obscure ones might not show up in these tools, so you will have to track them manually. Calculate your ROI, net of gas fees if possible. You might need another tool for doing that.
Use a hot wallet and a cold wallet
For current Defi transactions, I find the Metamask wallet to be the most convenient, since it is well supported by most services. But I don't consider it to be the most safe. For longer term holds, I like to keep my funds in a smart contract wallet like Gnosis, or Authereum. I consider these wallets to be safer, and I like the multi-signature feature. That way I can get another signer, in case something happens to me.
Some people will prefer hardware wallets to be the safest, but I don't find them very convenient, and would worry about losing mine. I also havn't seen proof that they are really safer (than something like Gnosis)
Take advantage of staking, if it is available (POS coins)
Otherwise, you will be losing out to inflation.
Make use of token sets for automated trading of reliable assets
The token set protocol is another good way to automate trades, save on gas and reduce risk. Version 2 will have even more powerful features, and also be supporting yield farming for better yields with managed risk. Here is an example of an automated arbitrage and yield stablecoin set.
In my opinion, the best way to deal with risk/reward is to invest of some of the yearn.finance vaults. There, you will get the benefit of the best returns, and you can even use their insurance coverage if you want to further reduce risks (and profit). The YFI project is a whole ecosystem, which has gotten a lot of attention for good reason, and deserves a whole article on its own. In the mean time there is a lot of info that you can read and follow on twitter, medium, youtube etc. for the latest news and developments.
If you decide to venture out on your own in the DEFI space, its a good idea to follow some, if not all of the "best practises" for managing risk that I talked about above. This strategy should serve you well during bad times, as well as good times.
Let me know what you think.