Decentralisation and potential for high returns have made Cryptocurrencies a popular investment avenue for investors globally. However, just like every other financial tool there are Risks of Cryptocurrency that may be overlooked at times, resulting in several challenges if not considered and analysed. 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. Individuals and companies interested in investing in cryptocurrency must adhere to strict internet security protocols to safeguard their assets.
- In December 2021, crypto exchange BitMart was robbed of US$200 million when hackers stole a private key to one of its hot wallets.
- As cryptocurrencies become more intertwined with the traditional financial system, industry heavyweights are racing for a long-sought goal of turning real-world assets into digital tokens.
- These investor protections are rarely seen in the crypto world, though that might change over time.
Cryptocurrency risk #3: the Greater Fool
The biggest problem with crypto is its volatility and lack of widespread adoption. Price instability makes it challenging to use as a reliable currency or store of value, while limited acceptance hinders its practical use in everyday transactions. So, if the appropriate authorities have not yet examined a cryptocurrency asset that you, for instance, have, there is a risk of that cryptocurrency as well as losing your funds. However, the many risks listed above suggest that nothing has changed yet. Decentralized transaction ledgers may dodge a couple of threats, but there are many other issues to consider.
How Do Market Manipulation and Fraud Impact Cryptocurrency Risk?
Sometimes exchanges even halt withdrawals during peak times, leaving traders helpless as prices plummet. One moment Bitcoin’s skyrocketing; the next, it’s nosediving like a kamikaze pilot. It drops like it’s hot—sometimes by double digits within a day. This level of unpredictability makes it nearly impossible to maintain a consistent trading strategy.
Cryptocurrencies are volatile types of assets.
Then the inevitable crash happens, and panic selling follows. Investors are sometimes reluctant to sell a stock because the capital gains tax will be substantial. Around the world, governments have responded differently to crypto, from adopting bitcoin as legal tender to banning it outright. It’s the dangers of investing in cryptocurrencies essential to recognize that Bitcoin isn’t a shortcut to sudden wealth; rather, it serves as a safeguard against the gradual depreciation of fiat currency. Consider it more as a “don’t get poor slowly” scheme, emphasizing its role in protecting wealth from the constant debasement of fiat currency. On the flip side, if you have a large position you are trying to exit, there needs to be enough liquidity to fill your position; otherwise, the price of the cryptocurrency has to fall.
Additionally, traders may want to reduce their exposure to minimize the overall risk of the trade. Known for being highly volatile, what are the risks of cryptocurrencies? Given the market’s unpredictability, it is recommended that you trade only funds that you can afford to lose entirely. Consider these funds allocated specifically for speculative purposes, and be prepared for the possibility of losing your entire investment. In the end, cryptocurrencies are not every investor’s cup of tea. Any of the risks above could be deal breakers for you — and that is perfectly fine.
Understanding the risks of trading cryptocurrencies
- The cryptocurrency market is also relatively young and lacks the regulatory oversight seen in traditional financial markets.
- It’s crucial to double-check recipient addresses and verify all transaction details before confirming any transfer.
- Holding your Bitcoin assets for a few days would have resulted in a significant loss in dollar value.
- Cryptocurrencies are a trustworthy and secure system because of the public ledger system.
- Decentralisation and potential for high returns have made Cryptocurrencies a popular investment avenue for investors globally.
- Cryptocurrencies like Bitcoin and Ethereum operate on blockchain technology, providing benefits such as transparency, security, and potential profitability.
As the 4th point of the IDDA technique, you must calculate your risk tolerance before deciding on the investment strategy that is suitable for your portfolio. 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. Some exchanges liquidate positions automatically if your losses reach a certain point. Terms like DeFi, staking, gas fees, cold wallets, NFTs—it’s like learning another language.
Within a matter of hours, FTX filed for bankruptcy, and millions of clients were stuck and lost money as they were unable to receive their account capital back. On the other hand, officials in India and China have declared cryptocurrencies illegal. Most markets fall somewhere between the extremes, and the U.S. government is still grappling with the issue of cryptocurrency regulation. A couple of high-profile court cases may bring some clarity to the legal framework, but they are part of a larger process, and these things take time. Now that you’re aware of the potential risks, let’s explore how to get started in cryptocurrency, including choosing a cryptocurrency exchange and setting up a secure wallet.
Many people usually invest in cryptocurrency to make thousands and millions but end up losing everything. During the three-year period from January 2019 to December 2021, there were 9 days when the total value of the crypto market dropped 20% or more in one day. In fact, the largest losses in crypto occur when risk aversion hits the market.
As crypto continues to gain mainstream acceptance, its purpose and practical application become increasingly significant. Today, you are required to file taxes for any cryptocurrency transactions. If you fail to do so, you might be in trouble as it opens a risk for the government and authorities to track your financial transactions and activities. Criminals have also relied on cryptocurrency to transfer their money into legitimate businesses. The flow of illicit transactions in cryptocurrency is attracting the interest of governments across the world, increasing the possibility of stricter regulations.
Some countries have started introducing crypto regulations, but the patchwork nature of these rules creates confusion and loopholes. Scammers thrive in this legal grey area, and it’s the regular traders who often pay the price. Cryptocurrency prices can fluctuate wildly from week to week, or even within a single day. On May 19, 2021, for example, bitcoin’s price dropped 30%, after the Chinese government cracked down on bitcoin mining and trading. Choosing the best crypto spot broker is crucial for trading crypto securely. Investors should look for a spot trading platform that has a good reputation, high liquidity, and low fees.
Cryptocurrencies rely on complex technological systems, primarily blockchain networks. While these systems are generally powerful, they are not immune to technical issues. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Read our handy overview for an education on this financial trend. It’s important to use crypto-trading services with hacker-proof security. Larger names, such as Coinbase (COIN -5.97%), Binance, and Kraken, are always under attack but rarely breached.
The increase in the number of trusted crypto exchanges will provide an opportunity for more people to trade. At Hoxton Wealth, we understand that the world of digital currencies is still evolving. If you’re considering adding cryptocurrency to your investment portfolio, our financial planning and investment services can help you weigh the risks and make informed decisions. Additionally, any transactions made with Cryptocurrencies are irreversible. For example, if you were to send a payment to the wrong wallet, there’s no legal recourse to get your money back. By definition, liquidity risk is the risk of not being able to sell (or liquidate) an investment quickly at a reasonable price.