Wildly fluctuating prices, a lack of consumer protection, and a never-ending conveyor belt of scams. For first-time investors, the crypto market is full of risk.
But it doesn’t have to be that way. Spend some time educating yourself, and you can significantly diminish the chances of something going wrong.
Here are the top risks you need to be aware of before you invest in cryptocurrency.
1. Market Volatility
The sharp decline in the value of cryptocurrencies in 2018 is well documented. The MVIS CryptoCompare Index has lost 80 percent of its value since January. That’s worse than the dot-com crash (78 percent) back in 2000.
Bitcoin—which peaked at $20,089 on December 16, 2017—has barely broken $7,000 since April 2018. It’s a similar story across all other mainstream altcoins.
But that only tells half the story. Volatility in the crypto markets has always existed. We’ve seen plenty of other similar crashes before:
- 2011: The first Mt. Gox hack resulted in a 95 percent loss.
- 2013: A possible banking issue in Cyprus saw 52 percent wiped off the value.
- 2014: The second Mt. Gox hack led to a 63 percent loss.
Ultimately, buying cryptocurrencies could result in losing everything you invested in them. You should never invest more than you can afford to lose.
2. Regulatory Issues
Because the asset class is so new, governments and banks have not yet formed a coherent fiscal policy for them. Therefore, there’s always a risk that their taxation status, trading rules, or even outright legality, could change overnight.
Once again, these uncertainties mean money you’ve invested in crypto carries more risk than your capital in established asset classes.
The ballooning number of altcoins represents a risk to an investor. It’s impossible to put an exact figure on it, but it’s thought there are between 1,600 and 2,000 in existence.
However, despite the lack of real-world adoption, there is still a considerable amount of capital invested in altcoins. According to CoinMarketCap, 15 have a market cap of more than $1 billion and 57 have a market cap of more than $100 million.
Even if you’ve read the associated whitepaper and performed extensive due diligence, you still might find that the coin you backed doesn’t amount to anything and the value drops to zero. The more coins that are in existence and competing against each other, the greater the risk of this happening.
4. Consumer Protection
Unlike traditional banks, cryptocurrency doesn’t have any official safeguards or insurances.
For example, whereas the Federal Deposit Insurance Corporation underwrites depositors’ savings to the value of $250,000 each in both banks and brokerages, crypto exchanges are not part of the program. If your exchange becomes insolvent, you will lose everything.
Similarly, exchanges get hacked on a worryingly frequent basis, often resulting in a considerable loss of money. Whether or not you get any rebate on your lost wealth depends entirely on the exchange; you are at their whim. If something similar happened at your bank, brokerage, or credit card, you’d get your money back swiftly.
5. Market Manipulation
Although it’s never been conclusively proved, it’s widely assumed that insider trading, collusion, and market manipulation is rife across the crypto sector.
Indeed, experts now believe that the huge crypto rally in the second half of 2017 was primarily driven by a small group of people with vast crypto assets working in tandem.
Even on a day-by-day basis, there’s plenty of evidence that points to manipulation. Coins shoot up by dozens of percentage points over the space of a few hours, only to dramatically fall back to their previous levels the following day. These incidents are referred to as “pump and dump” schemes and take advantage of people’s fear of missing out.
Sell walls (accumulating coins cheaply ahead of positive news) and dark pools (anonymous trading away from exchanges’ eyes) are other common market manipulation tactics.
Because crypto is so unregulated, all these morally-questionable schemes are harder to prevent. Nonetheless, they create a considerable amount of risk, especially for novice investors who are not familiar with the underlying market mechanics. If you fall into one of the manipulators’ well-laid traps, you could take a substantial financial hit.
6. Exiting the Markets
There may come a time when you want to sell your crypto assets and hold your wealth in fiat currency instead.
Unfortunately, the crypto market’s “off ramps” are troublesome for a lot of investors. Yes, the situation is improving, but it’s far from ideal.
There are a few factors which contribute to the complexity:
- Many crypto exchanges only allow withdrawals in USD. Some also allow GBP, EUR, and JPY, but the choice is minimal.
- Exchanges frequently require high minimum withdrawals with withdrawing to fiat.
- Lots of exchanges that support fiat withdrawals only accept a few highly mainstream cryptocurrencies. For example, Coinbase—one of the most popular ways to buy crypto in Europe and North America—only supports Bitcoin, Ether, Litecoin, and Bitcoin Cash.
- In order to withdraw fiat money, you typically need to go through the utterly tedious verification process. It can take months.
- Some exchanges have been accused of withholding funds for vague and nondescript reasons. Lawyers sometimes have to get involved.
So, what does that mean for you?
At best, you might be exposed to multiple exchange rates to withdraw your funds into your domestic bank account (for example, IOTA > Bitcoin > USD > GBP), thus introducing uncertainty into the value of your assets and increasing risk. At worst, your crypto assets might not be available if/when you need them.
7. Cryptocurrency Scams
Unfortunately, cryptocurrency scams are widespread. For a new investor, it’s easy to get sucked in. Statistics show more than $2 million was lost to scams in the second quarter of 2018 alone.
The two most commonplace scams are fake ICOs and Twitter bots.
ICOs are the crypto version of stock market IPOs. And like an IPO, they require considerable due diligence from a would-be investor. Sadly, many people don’t perform sufficient research. Scammers have been quick to respond. They create hype around a fake IPO, but once you transfer your cash, you will never hear from them again.
Twitter bots are designed to look like official accounts. They typically promise to pay you a fixed amount of a particular coin in a few days in exchange for a small deposit today. They are all scams—avoid at all costs.
You also need to keep an eye for Ponzi schemes branded as altcoins. Some of the most famous include Bitconnect, OneCoin, and Plexcoin.
8. Human Error
For example, if you have no experience of trading, investing, or FOREX, then crypto exchanges can be an immensely confusing place.
It’s all too easy to accidentally place an incorrect order, send your coins to the wrong wallet, or even lock yourself out of your account entirely. Some trading facilities built on the blockchain don’t even have a password reset function.
Of course, you’re also at risk of human error when managing your crypto storage. If you lose your private keys, you might be unable to access or use your assets. And even if you use a secure cold wallet, like a Ledger Nano S, misplacing it remains a real possibility if you don’t exercise caution.
Although we think these issues are the most pertinent risks facing first-time cryptocurrency investors, there are always more issues you need to watch out for.
Above all, be vigilant and make sure you fully research any coin, exchange, or company before handing over your assets to anyone.