Investing in cryptocurrency is not without risk. Investors should only invest money they can afford to lose. Past performance is no guarantee of future performance. Investors could lose some or all of their investment due to known and/or unknown risk factors. We do our best to mitigate these risks but can never fully eliminate them. Always do your own due diligence before making an investment. Below are the known risks we are aware of. Purchasers of our crypto products and users of our software applications accept and bear the burden of these risks exclusively to themselves.
Non-stable cryptocurrencies tend to have very high levels of volatility, much higher than the stock market. Even Bitcoin can drop 70% during a bear market. Investors who cannot handle such a large decline should not be invested in non-stable cryptocurrencies. Funds which are needed in the short-term should also not be invested into non-stable cryptocurrencies.
Smart Contract Risk
Our structured crypto products are built using Set Protocol smart contracts. These smart contracts could have bugs or vulnerabilities. Additionally, these smart contracts are deployed on the Ethereum and Polygon blockchains, which themselves could have bugs or vulnerabilities. These vulnerabilities, could lead to the loss of funds, undercollateralization, or unintended contract state. Set Protocol has completed two external audits with OpenZeppelin, ABDK Consulting, and Iosiro to find and fix any potential vulnerabilities. However, keep in mind, that security audits only reduce smart contract risk, not eliminate it completely.
Our tokens can trade on the secondary market at a significant premium/discount to the net asset value (NAV) of the underlying portfolio, due to a lack of liquidity. Our liquidity pools rely on traders arbitraging away the premium/discount so that NAV and liquidity pool token price are equal. If there are not enough traders doing this, then a premium/discount will exist, providing an opportunity for any arbitrage trader.
For example, if TCOR's liquidity pool price is $80, but the underlying portfolio value is $100, there exists a $20 arbitrage opportunity. An arbitrage trader would therefore, purchase TCOR from the liquidity pool at $80, and redeem the tokens for the underlying portfolio worth $100. This would in-effect raise the liquidity pool price to $100 if the discount is fully arbitraged away.
On the flipside, if TCOR's liquidity pool price is $100, but the underlying portfolio value is $80, there exists a $20 arbitrage opportunity. An arbitrage trader would therefore, issue new TCOR tokens worth $80, and then sell them to the liquidity pool at $100. This would in-effect lower the liquidity pool price to $80 if the premium is fully arbitraged away.
These are simplified examples, keep in mind that slippage/friction costs will affect the actual arbitrage profit.
Some of our underlying tokens are collateralized such as Wrapped Bitcoin (WBTC), ETH2x Flexible Leverage Index (ETH2x-FLI), or Compound DAI (CDAI). If the underlying collateral declines precipitously, or is lost or stolen, then the token becomes undercollateralized which could cause the token value to collapse.
Apart from market risk, idiosyncratic risk is the risk associated with an individual cryptocurrency such as Bitcoin. Using Bitcoin as an example, there are risks associated with Bitcoin that are only found in Bitcoin, and nowhere else. This applies to all cryptocurrencies and investors implicitly accept this risk with each individual investment they own. Another example is the unique risks of the Terra Luna blockchain which led to the failure of its algorithmic stablecoin TerraUSD (UST). The idiosyncratic risks associated with the Terra Luna blockchain were unique to Terra Luna and different from say, Bitcoin. Investors should of course be aware of these risks with each individual investment they make. Idiosyncratic risk can be mitigated through a diversified portfolio.
Market (Contagion) Risk
Cryptocurrencies do not exist in a vacuum and can be affected by external forces such as the stock market, bond market, government regulation, etc. This means that even if the likes of Bitcoin have no issues in and of themselves, their market price could be adversely affected by events such as a stock market selloff, or the failure of a cryptocurrency exchange. Our products could be adversely affected by contagion risk if the failure of a systemically important protocol leads the failure of others. No amount of diversification can mitigate market risk.
Impermanent Loss Risk
Investors who provide liquidity to our liquidity pools may be affected by impermanent loss risk. Impermanent loss happens when an investor provides liquidity to a liquidity pool, and the price of the deposited assets changes compared to when the assets were deposited. The bigger the change, the more the investor is exposed to impermanent loss. However, the investor only realizes the loss if they withdraw liquidity from the liquidity pool. Impermanent loss can be counteracted with swap fees but there is no guarantee swap fees will be enough to offset impermanent loss.
There are risks which are unknown and cannot be predicted, quantified, or controlled. These risks are a form of sunk cost and investors implicitly accept these risks by owning our products.