11 Major Risks Associated with Cryptocurrencies
You might have heard about famous cryptocurrencies or cryptos like Bitcoin, Ethereum, and Litecoin, but there are many other popular and highly valuable cryptocurrencies out there.
Although the cryptocurrency or crypto market has a ton of volatility, it also has the potential to earn you make a lot of profit and even make you become rich if you invest wisely and employ strategies that are in harmony with your personal risk tolerance.
It is exciting to invest in cryptocurrencies, especially when great returns can be made from an investment; however, as it is with other types of traditional investments, as you consider making great returns, also consider the risks or dangers associated with cryptocurrency investments.
Just like many things in life, cryptocurrencies usually come with their own load of risks; whether you want to invest in them, trade them, or just save them for the future, you must consider and assess the risks or dangers associated with them before you place a stake on them, or get financially involved with them.
When you make any investment, it is advisable to consider risk(s) which is actually related to the uncertainty surrounding the return(s) on investment you expect to make. Regulation risk and volatility risks are two of the most talked-about cryptocurrency risks.
In 2017, volatility, in particular, was uncontrollable, and the price of most major cryptocurrencies, including Bitcoin, skyrocketed above 1000% before it came down crashing and made some investors lose varying amounts of money.
Because crypto prices sometimes rise too much, and in a short period of time, they sometimes crash hard and fast; for instance, in February 2018, Bitcoin dropped from nearly $20,000 to as low as approximately $6,000.
In certain instances, cryptocurrency investing has been a get-rich-quick scheme for some people, but this doesn’t mean you should take a loan or your life savings and invest in cryptos.
You must consider the risks or dangers associated with cryptocurrencies, understand the different types of cryptocurrency risks, and then apply or develop an investment strategy that suits your risk tolerance.
Always remember that early Bitcoin investors waited on a long-term basis—for several years—before they saw any returns, especially substantial and great returns! If you can’t be patient enough to wait for meaningful returns on cryptocurrency investment, then it may be better not to invest in cryptos.
Cryptocurrencies are associated with a number of risks and mistakes that have cost some people a ton of money; however, risk could be relative and may require each person to approach it individually because what presents a risk to one person might not represent a risk to another person, and each person has their own unique lifestyle and financial circumstance(s). The following are the major risks associated with cryptocurrencies:
1. Risk due to the hype surrounding cryptocurrencies
One of the major reasons why cryptocurrencies have a lot of hype is that some people don’t know much about it and what they are investing in; they only know the names of cryptocurrencies and follow the voice of the crowd which is usually hyped.
In 2017, the general hype about cryptocurrencies was one of many drivers that created a surge in investments in the crypto market; however, and unfortunately, the hype made a lot of people invest and before some of them could figure out what was happening, cryptocurrency prices crashed and many of them suffered losses.
Ignore the hype in the cryptocurrency market, be patient and get the right knowledge about the cryptos you’re interested in investing in. Instead of gambling and taking a risk by making investments based on the current hype, find out more about the cryptocurrencies of your interest before you finally invest in them.
2. Risk due to security failure: fraud/cyber risk
Since the cryptocurrency market started with Bitcoin in 2009, scams, hacking, and thefts have been issues in the cryptocurrency market, and have temporarily compromised the values and prices of various cryptos.
Since the inception of cryptos, the criminal community and its criminals have been attracted to the crypto market, and have sometimes broken into cryptocurrency exchanges, drained cryptocurrency wallets, and even infected computers with malware that steals cryptos.
While cryptocurrency transactions are being conducted on or across the internet, cybercriminals or hackers use phishing, malware, and spoofing to target crypto services and computer security systems that have been designed to protect cryptocurrencies purchased by people. Once a cybercriminal successfully transfers any cryptocurrency out of a wallet, and the transaction is recorded on its blockchain, that cryptocurrency would likely be lost forever.
Softwares used by cryptocurrency platforms could be untrustworthy at times; in the past, sourcing of blockchain technology could have led to significant third-party risk exposure; as a result, many cryptocurrency platforms, which are usually unregulated, have been vulnerable to thefts and frauds more than regulated financial institutions have.
3. Risk due to negligence or forgetfulness
If an investor, registered user of a cryptocurrency exchange platform, or crypto wallet owner is negligent, then a cybercriminal or fraudster could gain access to the investor’s private secret key and steal cryptocurrencies from the investor’s digital wallet; in addition, any investor can lose their cryptos because of their own human error, forgetfulness, or memory loss.
There have been unfortunate incidences when cryptocurrency owners lost access to their secret keys because of their own ignorance; as a result, they lost access to the cryptocurrencies in their crypto wallets. In other cases, crypto owners have unintentionally deleted their key file, or broken the hard disk of the computer in which they stored or saved their cryptocurrency details.
4. Risk due to technological limitations
Nothing in life is perfect; even technological components, which usually have limitations, are constantly being developed and ungraded very quickly, and often uncontrollably.
Although Bitcoin and other popular cryptos are in high demand, newer cryptos or competitors appear on a daily basis. Despite the advantage that Bitcoin and other popular cryptos’ brand awareness have, there is a potential risk that their technologies and brands could lose value if other more advanced cryptocurrencies and technologies appear in the crypto market.
This implies that, with the influx of cryptos on a daily basis, investors might not be able to notice when the “popular cryptos” they invested in lose their real value.
Reports abound that the energy consumption and computational complexity of bitcoin mining are examples of the technological limitations of cryptocurrencies. Computational complexity may pose potential risks to people’s assets if we agree with the premise that complex systems fail in complex ways!
Although it’s true that each blockchain structure’s decentralized feature provides a certain type of protection that centralized databases don’t enjoy, not all cryptocurrencies are on the same level: not all blockchains are equal; therefore, investors should beware of risks due to technological limitations present in the types of decentralization that are inherent in many cryptocurrency projects.
5. Risk due to the probability that any cryptocurrency can vanish
There are currently thousands of cryptocurrencies are out there, and many more are being created every day; and it is highly probable that in a few or several years’ time, many cryptos may vanish, while others may flourish and become much more highly valuable.
Investors should assess the cryptocurrencies they wish to invest in and find out whether their goals will be worth any money or time in the form of investment. Do the goals of the cryptos of your interest make any sense?
Are the cryptos of your interest going to remove a limitation or solve a general problem that may continue in the coming years? Although you can’t erase the probability that a cryptocurrency would vanish, you can reduce the probability or eliminate the chance of investing in a cryptocurrency that could vanish.
Following the path of history, many of the cryptocurrencies currently popping up from every corner are likely destined to crash, become a bust, or head for doom!
6. Risk due to illiquidity (or lack of liquidity)
By definition, illiquidity is the potential any substance or form of investment—in this case, a cryptocurrency—possesses which makes it not to be readily or easily liquidated, sold, or converted into physical cash. It is important for any cryptocurrency or tradeable asset to exhibit liquidity, or be easily converted into physical cash.
The absence of liquidity can be a problem in the crypto market; in fact, it is one of the factors that have led to the high volatility in a number of cryptocurrencies.
Whenever a crypto has low liquidity, there is a tendency for the price of the crypto to be manipulated because one person or entity can use a huge capital to make massive orders and easily move the crypto market in their favor; this can make the value and price of the crypto to be volatile and pose a risk to other investors who have different goals.
Whenever you want to choose a cryptocurrency to invest in or trade, consider its level of liquidity by analyzing its popularity, level of acceptance, and the number of exchanges that accept it on their platform and allow people to make trades with it. Although many cryptocurrencies may have a lot of potentials, they may put investors in trouble in the future because they lack some level of liquidity.
7. Risk due to uninsurability
The illiquid and intangible nature of cryptocurrencies increases their uninsurability because it is difficult for them to be converted into cash, especially in the form of traditional fiat currencies.
Cryptocurrency illiquidity and intangibility make crypto assets insecure and highly uninsurable, and also creates a tendency for insurance companies to refuse to provide insurance for cryptos because of the logical standards they have in place for issuing insurance.
Despite the reported interests that insurance companies have in cryptocurrencies, based on today’s standards, the majority of cryptocurrency companies and cryptocurrency assets are either uninsurable or underinsured.
8. Risk due to volatility
As a result of unexpected movements in the crypto market, investors can easily be caught off guard, especially those who want to make gains on a short-term basis: the cryptocurrency market can suddenly move in a direction that’s different or even completely opposite from what most people expect.
If an investor isn’t aware of how volatile the cryptocurrency market could be, they could lose the money they’ve invested in any crypto asset(s). The best way to combat cryptocurrency volatility risk is by investing in cryptocurrencies on a long-term basis.
It’s important to consider volatility if you want to invest and make gains on a short-term basis; however, if you have a long-term investment plan, volatility can present you with a great opportunity.
9. Risk due to governments’ constant regulation changes
Although one of the things that initially attracted people to cryptocurrencies was lack of regulation, especially through various governments which have individually different standards, the constant regulation changes (regarding cryptos) made by some governments often put investors at risk because each investor reacts differently—even in detrimental ways—when governments make unexpected regulation announcements.
For instance, in 2017 when China decided to halt the activities on several trading platforms, the price of Bitcoin plummeted. In 2018, within 24 hours after various governments in Asia made announcements concerning expected regulatory changes, there was around a hundred billion dollar drop in the cryptocurrency market.
In 2018, each apparently little regulation announcement caused unnecessary price fluctuations of major cryptocurrencies and created a ton of volatility. Governments have been constantly changing regulations regarding Bitcoins, and the changes have caused Bitcoin price fluctuations and made Bitcoin volatile at certain points in time.
10. Risk due to the nature of individual cryptocurrency markets
Generally, cryptocurrencies aren’t backed by any national or international organization, any central bank, and any credit or assets. The nature of each crypto market, as expressed through the value and price of each crypto, is solely determined by the degree of interest that investors or participants show towards the crypto, especially through the transactions and trade volume of the crypto.
In other words, the value of a crypto is determined by and created from the interest that participants show in the crypto; loss of interest or confidence from participants could affect or collapse trading activities and also drop the value and price of the crypto.
The nature (price and value) of each crypto is unpredictable and poses a risk because it is highly probable for the price and value of each crypto to deteriorate because of hoarding; the price and value are often fuelled by speculative demand which is unpredictable.
11. Risk of facing strict taxation
When cryptocurrency investing initially started and was gradually becoming, it was difficult to find anyone paying taxes on their profits or gains. However, as the crypto market continued to expand and governments plan on regulating it much more, various governments may become stricter on taxation.
As of 2018, the U.S. Internal Revenue Service regarded each cryptocurrency as a “property”—just like each house—despite the fact obvious fact that each cryptocurrency is actually a currency. The implication of this is that transactions involving the use of cryptocurrencies are subject to capital gains tax.
Therefore, if you live in the United States, you face the risk of experiencing stricter tax, now or in the future, especially if government authorities make unfavorable changes in tax laws, such as an increase in tax rates, limitation of deductions, and elimination of tax exemptions.
With the current level of increasing interest in cryptos in every country, it may be difficult or impossible to predict how strict or complicated taxation on cryptos would be in the future. Although almost all investments are susceptible to increases in tax rates, cryptocurrency taxation is blurry because most governments or regulators haven’t yet agreed on or figured out what each cryptocurrency token actually represents.
Investing in cryptocurrencies could be risky nowadays, especially on a short-term basis, and there is not always any guarantee of making minimum profits. Investors have to understand what the cryptocurrency of their interest is about and have a clear strategy or plan of action for all types of unpredictable scenarios that could come into play. In addition, each investor—experienced or inexperienced—should invest only the amount(s) of money that they would be willing to lose without falling into serious consequences.
Take matters into your own hands as much as you possibly can: before you choose a cryptocurrency to invest in, or an exchange platform to invest on, inquire about its level of security on its website, and whether the exchange platform encourages safety by participating in any bug bounty programs. In addition, ask the right people about the crypto exchange of your interest.