Cryptocurrencies have exploded in popularity over the last decade, and almost everyone is talking about them or investing in them. However, cryptocurrency investments are unlike any other in the financial system. They defy conventional investment trends and are prone to ludicrous swings.
There are over 10,000 cryptocurrencies and a slew of cryptocurrency exchanges, with more being added daily. That's a lot to take in, especially for first-time investors. This article will go over the biggest risks that new and experienced investors should be aware of in this wildly volatile market.
The 9 Biggest Risks for Crypto Investors
Unlike physical money (or fiat), cryptocurrencies are not backed by banks or governments and are highly speculative. Cryptocurrency transactions exist as digital entries on a blockchain. Cryptocurrencies are a trustworthy and secure system because of the public ledger system.
While the blockchain may aid crypto security, the decentralized nature of cryptocurrency, combined with the anonymity it provides, poses risks. The following are nine significant risks associated with investing in cryptocurrency:
1. Volatility
Volatility is one of the most basic indicators of an asset's financial health, and cryptocurrencies are one of the most volatile investment options out there.
In early 2021, Dogecoin rose by over 20,000 percent, but by May 2021, it had lost over a third of its value. Wild speculation over the cryptocurrency's future sent the price soaring, both up and down.
Speculation fuels the cryptocurrency market, with some investors quickly buying and selling their holdings as soon as there's a sign of a price drop. A single negative popular tweet or news story about a cryptocurrency could cause its price to plummet quickly.
Still, there are signs that the crypto market is getting its act together in terms of volatility. Large trading and investment firms have recently acquired significant stakes in most cryptocurrencies. Those cryptos may begin to exhibit healthy volatility thanks to the stabilizing influence of these major companies.
2. Cybertheft and Hacks
Cryptocurrencies are held in digital wallets and traded through digital currency exchanges. Cryptocurrencies are particularly appealing to cybercriminals because of their online dependence and anonymity. To gain access to cryptocurrency wallets and trading platforms, criminals use a variety of phishing attacks.
Individuals and companies interested in investing in cryptocurrency must adhere to strict internet security protocols to safeguard their assets. Being aware of the latest threats is also helpful, as is understanding how to protect your crypto assets and crypto-wallets.
3. Decentralization
The lack of a central authority is arguably one of cryptocurrency's most appealing features.
But, this absence has drawbacks, especially when things go south. For example, in most online financial transactions, electronic money transfer is usually backed and mediated by a financial institution. So, if there's a problem with the transaction, you can easily contact them and resolve it.
With a cryptocurrency transaction, this isn't possible. Its decentralized nature makes it difficult to pinpoint the correct entity with which to file a transaction dispute. As a result, most cryptocurrency investors are advised to trade through reputable digital currency exchanges.
The majority of the top exchanges have excellent customer service that can assist with almost any problem. Still, the decentralized nature of most cryptocurrencies makes resolving legal disputes nearly impossible.
4. Risks Associated with Peer-to-Peer Transactions
A peer-to-peer (P2P) platform is a cryptocurrency marketplace that connects crypto buyers and sellers directly. On a P2P exchange, any cryptocurrency transaction is paid directly between the two parties.
These exchanges are one of the simplest ways to convert cryptocurrency into fiat money. Yet, the human factor is where mistakes or negligence can cause your asset to be lost. Furthermore, there is always the risk of scams and fraudulent schemes, such as a buyer refusing to pay for cryptocurrencies received or a seller refusing to send the tokens, and so on.
Finding a P2P platform that provides a digital asset escrow service is the best way to avoid most of these schemes. The cryptocurrencies are held by the platform during the transaction using this service. The asset will be released to the buyer as soon as the buyer completes the payment process and the seller confirms receipt. This guarantees that both parties get what they want. If a disagreement arises, a platform representative will resolve it.
5. Loss or Destruction of Private Keys
Cryptocurrencies are built on a cryptographic system that uses pairs of keys to authenticate transactions. One is a publicly available public key, and the other is a private key kept secret and used for identification and authentication. A private key is automatically generated when you open a crypto wallet and grants user ownership of funds in that wallet.
The loss of a private wallet key means losing control or access to any cryptocurrencies in that wallet. In fact, approximately 20% of all Bitcoin lost is due to the loss or destruction of private keys. Therefore, it is crucial that you regularly back up your private keys, preferably on a secure and isolated computer. Also, never store your private key online, especially if it is not in an encrypted format.
6. Unregulated Trading Platforms/Exchanges
The popularity of cryptocurrencies has resulted in an increase in the number of cryptocurrency exchanges and trading platforms. As a result, picking an exchange has become more difficult. Cryptocurrency exchanges offer the same level of services to the financial market as traditional financial institutions.
However, the lack of regulatory oversight has aided the growth of scam exchanges and market manipulation in crypto trading. Some trading exchanges have exorbitant trading fees and no policies to prevent manipulative or suspicious trading, while completely unregulated exchanges may employ predatory practices.
Exchanges may charge exorbitant commissions while also making withdrawals nearly impossible. Others may have weak security, making it simple for scammers to steal your money.
The best approach is to find trading platforms and exchanges with reputable security and noteworthy reviews. Always read the fine print of their terms of services and avoid platforms with unrealistic claims.
7. Regional Regulation
Regulation is one of the most serious threats to cryptocurrency's continued growth. Governments all over the world have enacted regulations to limit the use of cryptocurrencies in their respective countries. Many governments regard cryptocurrencies as a way to circumvent financial regulations and facilitate money laundering.
For the time being, most governments are researching how to integrate cryptocurrencies with their existing fiat currencies. Others, such as El Salvador, have fully embraced cryptocurrencies, with some even launching or considering launching a national cryptocurrency. Still, there is a high risk of legislation that restricts the use of cryptocurrency.
8. Currency Conversion Risks
Crypto prices frequently fluctuate, making them a high-risk investment. For example, Bitcoin climbed from $20,000 in December 2020 to over $65,000 in April 2021, before falling to around $28,000 by June 2021. You would have made a significant profit if you had purchased Bitcoin in January and sold it by late April. Holding your Bitcoin assets for a few days would have resulted in a significant loss in dollar value.
As most cryptocurrencies are volatile, their value fluctuates in relation to traditional currencies. In addition, because cryptocurrencies are speculative, investors are at the mercy of whatever value they have at the time of selling.
9. Taxation Laws
Cryptocurrencies are classified as capital assets, which means they are subject to the same tax regulations as stocks. According to the IRS, when you use cryptocurrency to buy goods and services or exchange it for other currencies, you are subject to capital gains tax. Also, any cryptocurrency obtained through mining is taxable.
Cryptocurrency investors are required to report their earnings as income on their tax returns. However, not all cryptocurrency transactions are taxable. Purchasing cryptocurrencies, storing them, and transferring them between exchanges or wallets are all exempt. Cryptocurrency laws can be complicated, but you can catch up to speed by reading the IRS's virtual currency guidelines.
The Bottom Line
Investing in cryptocurrency is extremely risky, and you must be prepared for any eventuality. It's the Wild West, and because of its decentralized and unregulated nature, it's rife with con artists and crooks. Inexperienced investors should invest only what they can afford to lose without suffering serious consequences.