Startup Risk Management in Bitcoin: How To Not Get Killed

Because of the high amount of variables and unknowns in Bitcoin, proactive risk management is required to ensure that your business sails through storms and blows without losing momentum. Right from the start, when you think you are just wetting your feet, you will see high severity security and financial risks materialize. Ordinary startups, because they don't have to deal with such scenarios early on, normally can afford to focus almost solely on financial performance. This is not the case with Bitcoin. Here you must be prepared to deal with events of considerable risk level from day one. Knowing the main risks, and cultivating an internal culture of self supervision, will ensure you survive.

Liquidity Risk

This is the risk that the capital you allocate to your current project, or the funding you have previously received from stakeholders, suffers a sudden, huge loss in value because you were holding it in Bitcoin. Most builders have studied Bitcoin and are driven by a strong belief in its fundamentals. This can tempt them to keep everything in coins hoping to capture some of the upside potential. However, keeping a business up on its feet requires a continuous ability to meet its immediate demands for cash. The daily operations of a business consist of several processes taking place in parallel such as marketing, development, customer support, moderation and so on depending on the business in question. These processes are the lynph of life for any startup. Exposing your funds to price volatility can cause losses that force you to sacrifice an entire processes. That would decrease your business's chances to succeed and its fitness to compete. Your servers, developers and marketers cannot wait for the next bull cycle to resume to get their pay. As result, for efficient liquidity management, you are better off keeping the funds allocated to your Bitcoin business in fiat.

Market Targeting Risk

The process of controlling market and commercial risk begins by identifying the target market and identifying your risk capacity as a business. Risk bearing capacity denotes the ability of your business to cover the risks associated with your commercial activity. The core questions here are:

  1. Whom do you want to serve?
  2. Why do you want to serve them?
  3. For how long will you serve them?

Once the target market has been identified - eg: people who are prone to using Bitcoin for commerce because they would save money on commissions and transaction fees - the next step is to conduct quality market research. This is to learn about the needs, opportunities, constraints and aspirations of your intended customers. In the scenario of a bcommerce business, "HODLers" would not be your priority group. By collecting sufficient information about your intended customers you can then tailor your products or services to their needs reducing market risk. However, in trying to expand you should also be aware of capacity constraints and premature expansion risk. If demand exceeds expectations then you will have to be ready to invest more in infrastructure, in maintenance or change pricing strategy to serve only high priority customers. New services bear new risks, resisting pressure from stakeholders (such as "the community") to start working on new projects without the necessary components (staff, skills, funds) is important to configure your risk bearing capacity objectively. Parameters like customer reach (are your customers only crypto users or are you onboarding also users from outside crypto?) and customer retention rate (% of sales come from existing customers) can be used to monitor these risks.

Dependency Risk

Dependency risk is the risk that the initial support provided by an external sponsor or company, while making it easier to remain sustainable in the short term, might undermine the effort to build a business that is viable in the long term. Exposure to such risk occurs, for example, when because of a big donor you start offering a service for free or lower prices adventurously to levels that wouldn't cover for costs. In other words, you stop managing your enterprise as a business and become dependent on external funding. An adequate pricing strategy is important to limit exposure to this risk.

Moreover, when choosing to build in a chain that has swayed from the Bitcoin Whitepaper consensus model it is important to assess dependency risk. If you decide to build on such chains their dependency risk will be inherited by your business. To assess dependency risk you must evaluate the forces behind such changes. If we stratify market players based on the amount of dependency risk they bear, the ones with the least dependency risk are also the best expression of market demand. In fact, these organizations are self-sufficient because capable of providing the appropriate services to their intended clientele in a sustainable fashion. They do not rely on donations but on revenue. Following changes wanted by a particular development team (such as Blockstream or Bitcoin ABC) means you are exposing yourself to their dependency risk. Often times these teams rely on short term funding and do not have an underlying business model that would allow them to exist independently as businesses in the long term. Today the Bitcoin fork with the least dependency risk is Bitcoin SV (original Bitcoin Whitepaper consensus rules).

Operational Risk

Operational risks are the vulnerabilities you face as a business in your daily operations. As a bitcoin business you will always bear a lot of risks that fall in this category such as security risk, internal fraud risk, human error risk and efficiency risk. Human errors in Bitcoin can have very high loss severity impact. As a bitcoin business you will be exposed at some point to losses caused by haste, carelessness, poor training and the tendency to neglect the identification and correction of previous errors. Keeping error logs helps mitigate this risk.

Internal fraud is another important risk for wherever there is money, there is an opportunity for fraud. Because of the intrinsic nature of Bitcoin, you will experience fraud perpetrated by staff or corrupted relationships with customers. Strong information management (eg: cold wallets), clear job segregation and proper staff vetting are important processes to mitigate this acute threat.

Inefficiency risk is the ability to manage costs per unit of output. Wasting resources can negatively affect your ability as a business to absorb a loss caused by human error, a security breach or internal fraud. Efficient allocation of resources is important, among others, to maintain reserve funds. These can ensure the continued existence of your business by absorbing losses inflicted by risks that have materialized. You can improve efficiency in 3 ways:

  1. work on increasing the number of customers by building a business that appeals to the wider market (non crypto users);
  2. streamline processes such as internal controls, marketing, moderation and development to improve productivity
  3. cut costs (eg: outsource small tasks to freelancers on Fivebucks)

The first 2 goals are closely related, both seek to increase the number of clients and units of output per unit of cost. The third addresses the cost control side and is focused on operating expenses. It is achieved, among others, through automation of repetitive tasks, improving product design and/or software architecture and by outsourcing.

Legal Risk

Legal or compliance risk is the possibility that you might be breaking the law. Bitcoin's pseudonymous nature and non reversible transactions make it attractive for criminals who may exploit your business for money laundry or to engage in fraud for which you may be liable in the end. As your business volume grows it is important to implement proper AML and KYC solutions.

These 5 risks, if managed inappropriately, will end your business's life in few weeks after launch. A hack (security risk) can wipe out your entire funds. A hash war can put your business in limbo for weeks (liquidity & operational risk) or it can bankrupt your main donor (dependency risk) and put you on the street. A price crash can cause a sudden loss in purchase power and force you to sacrifice important processes such as marketing that will depress your business's potential. To survive you need to get used to identifying and managing risks long before they are visible to outsiders. Over 50% of ordinary startups die in the first year, in Bitcoin your startup could get killed less than a month after launch.

Author Fivebucks
Published Mar 06, 2019
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