What is Financial Risk?
Financial risk is a phenomenon that concerns all investors, companies, institutions, governments, or communities — any party that has the ability to lose or damage their financial assets. The degree of financial risk is dependent on many factors — everything from regular people’s sentiment to production figures to global geopolitics. In this context, risk is the probability of a party losing money, capital, or assets in general.
If you have questions like what is financial risk and want to know how to deal with financial risk when trading or investing in the cryptocurrency market, then you will find the answers in this article.
What is financial risk?
Regardless of whether someone’s initial holdings (capital) are large or small, the potential to lose this capital as a result of financial transactions or investments defines financial risk in the broadest sense. The risk level may be different between individuals who invest and different sizes and sub-titles for companies and organisations that take out loans and carry out commercial operations.
Financial risk and financial risk indicators vary on different scales. For national governments, an example of financial risk is taking on foreign loans without proper control over monetary policy, with a default affecting all the individuals living in the country. Likewise, companies need to manage financial risk indicators and risks, so they don’t go into the red or have to declare bankruptcy.
There are financial risks for individual investors too. The investment strategies and decisions of individual investors putting capital into shares or cryptocurrency may involve or create financial risks. But similarly, individuals who keep their money in cash and or entrust asset managers may also incur risks.
It is always recommended that users who trade and invest in the cryptocurrency market perform the necessary education and research risk management principles. They should also always make transactions in accordance with their own risk-return levels.
What are the indicators of financial risk?
A risk indicator is a measure used to evaluate or gauge the scale of a potential risk. A risk indicator can be conceived of as an alarm with upper and lower limits, sending out a warning when key numbers breach these limits. Financial risk indicators can also be metrics that help to measure market risk, regulatory changes, or competition risk. In cryptocurrency markets there are unique indicators — these could be market conditions, the actions of authorities to create or alter cryptocurrency regulations or developments specific to each crypto asset.
A good identification of risk indicators helps parties to manage their risk. Knowing the potential risks of a market, or specifically a crypto asset market, will give a good indication of the actions to take and at which breaking points.
Financial risk indicators, as they serve to measure, also determine criteria such as success and failure that are defined beforehand.
Types of financial risk
There are different types and scales of financial risks for parties such as governments and companies compared to individual investors.
These are the risks that occur when there is a change in local or global market conditions — cryptocurrency or traditional financial markets for example.
Companies and individuals use various forms of credit. They must have sufficient funds and liquidity to enable them to cover loan payments. In this context, the risk is the potential of defaulting on loans.
Liquidity is the ease at which a cryptocurrencies or traditional financial assets can be converted into a desired fiat currency. Investors want to be able to buy and sell very quickly in the cryptocurrency market. Liquidity risk refers to how quickly investors are able to trade their assets into cash when they require. The slower the process, the more risk.
Operational risk refers to the potential for failures, fraud, individual investors’ errors or financial losses incurred at any stage during the processes of large or small-scale organisations or individual investors.
What are the financial risks in cryptocurrency markets?
Cryptocurrency users have their own key set of responsibilities. They should protect their information on trading platforms like their username, password, two-step verification process and other features. They should also ensure their cold wallet details are secure. Cryptocurrency users can manage financial risk by ensuring the security of their accounts — meaning their crypto assets will be safer.
Furthermore, it may be beneficial for users or trading platforms to develop measures and strategies to limit the risks market conditions may pose. Developing measures and strategies can also prevent other risks, especially the risk of both parties losing money.