By This is a great question, as most people have no idea. Traders have to balance the risks associated with exchanges that can be hacked and are centralized with the fact that assets held in cold wallets can’t be traded.
They Don’t Keep All Their Coins in “One Basket”
To start with, I think one of the biggest misunderstandings of trading, in general, is that traders are making frequent trades on a minute-by-minute basis. While small portions of a professional traders portfolio may be used for this type of daily trading, more often than not, a much larger portion is used for longer-term positions. These longer-term positions are likely held for weeks, if not months or years. So, while the percentage of a portfolio that is used for day trading can be left on exchanges, longer-term positions are usually locked away in cold wallets.
Additionally, traders use a variety of techniques to mitigate losses in a “flash crash” situation. One such example is leverage.
If a market looks like it is turning very quickly and major losses to the overall portfolio will be realized, using leverage on a short position can ensure the risks associated with that crash are minimized over the entire portfolio.
For instance, let’s say that I have 100 BTC – 90 BTC stored in cold wallet, while 10 BTC is being used to actively trade. In the event of a flash crash where the market is retracting substantially, I could open a short position with 10x leverage. That means if the market was to crash about 10%, I would actually make the losses back over the entire portfolio with the short position.
So, while my 90 BTC in storage was now only worth 81BTC prior to the loss, the coins on the short position would have doubled in value and be worth 20. That means I was able to make a profit of 1 BTC or 1% return in terms of USD value.
Real Traders Won’t Panic-Sell
Another common misconception is that traders are not willing to ride out the volatility in the market. If the overall market is down trending and the market fundamentals are pointing to that movement being completely without reason, I would likely stay in the position knowing it would bounce back. In this case, I would not need to move anything from cold storage to an active exchange. I might sell to buy back in at a lower price with the coins that are in my daily trading portfolio, however, the majority of the coins locked away would be held there, because I believe the price targets will still be met in the future.
When it comes to day trading, most traders have a system that becomes their mantra. For example, if you trade for 4-hour periods per day, you would transfer funds into the exchange, make your money and then cash out to your reserve currency prior to ending your session, transferring them back to your cold wallet. It actually becomes part of the start and end of day routine, and you get used to doing it.
They Also Choose Their Exchanges Wisely
Though hacks are highly publicized when they do happen, large hacks are actually a very rare occurrence in the sector. It is a fact that bad news tends to travel a lot further and faster than good news. So, when a hack does happen, it becomes exponentially pushed harder by the media than when an exchange has operated for years without any issues.
Let’s look at the recent hack of a popular exchange where $480 million in NEM was stolen. The exchange remained solvent and has agreed to cover those losses. The reason for this is that the exchange in question makes over $2 million in fees per day, and has been around for nearly 2 years. So, while the loss will hurt, it will only take 6-8 months to recover those losses. Considering the sector’s growth, it will likely be even less time. By covering those losses, the exchange has built a trust relationship with their clients, which translates to more volume, more referrals, and more fees.
Traders don’t just trade on any exchange. We look for exchanges with clear guidelines to how much deposit they keep in cold storage and how much assets they currently have. Any exchange that doesn’t have these records publicly available is never trusted by a professional and we would not put our own or our clients’ money in those exchanges. As a general rule, only the top 3 or 4 exchanges are actually used by traders, and this is evident in those exchanges having far more volume than others.
In the chart below, you can see that, out of the 1000’s of exchanges, few actually have enough volume to be considered major exchanges and those are the ones with the best security and solvency practices.
They Don’t Always Use a Centralized Exchange
Another trick most professional’s use in the crypto sector specifically is to use decentralized exchanges. These are exchanges that have no centralized authority and don’t keep funds online. They work like marketplaces where sellers and buyers transact directly.
These exchanges are used in the rare case that a specific coin or token is yet to be listed on major exchanges and the trader is looking to get in very early in the adoption cycle. This is actually very rare, as many traders would have already gotten into that company during the early pre-sale or ICO stages of the project. In the rare case that they didn’t and see a potentially profitable opportunity, exchanges like Etherdelta are used to get in just after those ICO stages and prior to top exchange listings.
Additionally, when traders are looking to sell larger volumes of coins and convert to cash, the majority will use either the very big exchanges that actually convert to fiat and deposit to bank accounts, or will go to in-person exchanges that make the transaction process a little quicker and more easier to access. For example, using a fiat-to-coin exchange like Localbitcoins can actually mean more profits, as you can set a price usually 5-10% over current market levels. Also, exchanges like Robinhood and TD Ameritrade have begun allowing for cash outs directly into asset accounts that can be used to fund trades into other markets, like the stock or forex markets.
Real Professionals Know What They’re Doing
Considering all these strategies, it is very rare that a professional would get caught in a bad situation where they are either using an insolvent exchange or they are not holding most assets in cold storage. Most people who do get into these types of situations are non-professionals, who trusted exchanges they shouldn’t have, and didn’t get professional advice prior to commencing their investment and risk mitigation strategy.
Unfortunately, in the current sector, most people assume that a professional is not necessary, as it is easy or simple to make returns. This is actually the complete opposite to the conventional markets, where less than 1% of investors actually manage their own portfolios. In cryptocurrency, it is estimated that 99% manage their own portfolios. They are neither qualified or understand the risks and get hurt when these types of situations happen.
The main concern for most investors is that it is very difficult to identify a professional from a non-professional in the current unregulated sector. Most people are weary that handing over their coins to a third party can result in potential losses by scammers or those that pose as professionals but have little true professional experience in cryptocurrency or financial markets, period. But we’re here to help.
CoinBeat is a publication that looks to fill that need. It connects cryptocurrency investor with expert cryptocurrency traders and industry professionals like myself. It allows for investors to copy and piggyback their portfolios on the picks and positions of experts who understand the sector and know how to minimize risks while maximizing profits.
For those interested in learning some of these tips and strategies, make sure you subscribe to CoinBeat and check back into Satoshi Smooth’s Corner for advice, tips and tricks that will surely make you a better trader and investor. If you have any questions or content for me that you would like me to cover or clarify, email asksatoshi@coinbeat.com and make sure to subscribe to CoinBeat to be among the first to get access to new information and editorials that matter!
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