Now that we have learned what cryptocurrencies are and how they work it is important that we follow that up with what risks they carry.
Cryptocurrencies provide a lot of upside in the long term as their volatility allows them to provide investors with high yields. Since its inception in 2009, Bitcoin has provided a yield that is over 50,000%. Now imagine someone invested $100 in Bitcoin when it was $1, that means their investment should be worth $5,000,000 now in 2021. Sounds fantastic, right? Well, not all that glitters is gold and although Bitcoin is digital gold (pun intended), it does come with a huge amount of risk in the short term. In this article, we would touch on the three most important risks that you need to be aware of and these are: price volatility, lack of regulation and the vulnerability to cybercrime.
Price Volatility:
The prices of cryptocurrencies are extremely volatile and this can mainly be attributed to the fact that the cryptocurrency space is new and so there is still a lot of discovery to be made there in terms of price, adoption and regulations, and this makes the market quite speculative. As a result, when there is news of any sort in the market, it swings the price of cryptocurrencies in either direction. Sometimes price changes mildly and other times it changes violently depending on the magnitude of the news/perception of the investors. Since it’s so speculative, investors are less informed as they are in the traditional markets and so, many times they tend to overreact to news thereby causing the price to lose a lot of value quickly or gain a lot quickly. For example, in February 2021, Tesla announced that it had invested $1.5billion in Bitcoin and that it was also going to start accepting payments in Bitcoin for its products. This sent Bitcoin up 15.1% to a new all-time high in a single 4-hour candle, with successive candles taking the price even higher. However, only three months after this the CEO of Tesla —Elon Musk, tweeted that his company has suspended the use of Bitcoin to purchase Tesla’s due to concerns about how green the energy used to mine Bitcoin is. This sent the price of Bitcoin down by 10% with 5% of that being within the first minutes of his tweet. Although the currency was already in a downtrend prior to Musk's announcement, this was the news that is believed to have sent Bitcoin into a mini bear market that lasted almost three months, with price retracing almost 50% of its value. Ironically, Bitcoin uses less energy than other forms of currency such as fiat and gold, meaning it’s actually a greener option of currency. However, because it's a speculative currency and most people refuse to do their research, investors overreacted to the news from Musk in May.
Although cryptocurrencies tend to follow Bitcoin’s trend, their prices can also change based on their own fundamentals. It is important that all investors protect themselves from the risk of price volatility that comes with cryptocurrencies. To protect yourself from the risk that comes with volatility, it’s important to be as informed as possible about any cryptocurrency you want to invest in because not all cryptocurrencies have good fundamentals and a strong community, and these are two of the most important things that can help any project survive a harsh crash. A good place to start would be by reading their whitepaper after which you can do further search on progress being made with their projects and if they are widely accepted by the community. Secondly, it is also important to find a good entry price when buying any cryptocurrency as this minimizes your unrealized losses in a crash. Avoid getting into projects after they just had a run-up because chances are that you’ll be getting in at the top and the price will correct (have a slight pull back to previous levels) after that. It’s advisable to learn technical analysis to help you with this.
Lastly, just HODL. Hodl is a commonly used term for Hold in the world of crypto. It originated from a misspelling of hold but some people will tell you it means "hold on for dear life", which kind of makes sense still. As mentioned earlier, Bitcoin and many other cryptocurrencies have provided their investors with a lot of yield over the years even though they have suffered hard crashes in between. Therefore, it would be wise to just invest and hodl over the years, not minding the dips because you know it will bounce back higher. This is why it’s important to do your own research and get to understand the fundamentals behind every coin you invest in because as said earlier, only the coins with great fundamentals and/or community can survive a hard crash. Also make sure that you only invest what you can afford to lose so that FUD (Fear, Uncertainty, and Doubt) does not lead you to sell your cryptocurrencies too early, as doing so will cause you to not only lose the current value but you’ll also miss out on future gains which might then cause you buy in at a much higher price because of FOMO (the fear of missing out).
2. Lack of regulation:
The cryptocurrency space is one that is highly unregulated as this is a new asset class with complex characteristics. Therefore, the government is yet to grasp the nature of this asset in order to give adequate and suitable regulations. However, 2021 has seen a lot more recognition for cryptocurrencies with more corporations and some countries adopting it as part of their payment/currency options. Additionally, the American FED has also started to talk about cryptocurrency regulations in some sense but at the moment, they seem more concerned with regulating stablecoins e.g. USDT, and their unbelievable stake APY’s. The risk in cryptocurrencies being unregulated is that people and corporations can take advantage of them in unethical manners and this may be harmful, especially for the smaller individual investors and those new to the space.
3. Vulnerability to cybercrime:
Although transactions on the blockchain can be tracked, and bitcoin along with some other cryptocurrencies are difficult to hack, they can still be hacked as they are indeed digital. In most cases, hacking and cryptocurrency theft has been done via cryptocurrency exchanges because when you buy cryptocurrencies on an exchange, you do not actually own them because the exchange still has the right to the keys. This is why there's a common saying in crypto - "not your keys, not your coins", which essentially means you do not have the sole right to the coins you bought. Hackers usually target the exchange itself and this affect's individuals who store coins on the exchange. The most recent incidents happened in August 2021. The first was on a Japanese exchange called Liquid Global. In this incident, $100 million was the total amount lost by the customers affected. The company insisted that it will pay back this amount to those customers, but in cryptocurrency, it’s not just about the money being paid back but the positions the traders worked hard to take, great entry prices in great projects, and of course, this affects the future returns they were hoping to receive from those investments. This just means that they have to start all over and that could be very discouraging in the short term. Also in August 2021, was the attack made on Polynetwork which is a cryptocurrency platform. Bigger than the attack on Liquid Global, this attack was estimated at over $600 million. Similar to Liquid Global, Polynetwork returned the funds back to its customers but as mentioned above, the loss weighs much more than the funds.
To protect yourself from cyber related risks, it is important first of all to use secure platforms. Although any cryptocurrency platform can be hacked, it is much safer to use a platform that is as secure as possible as this makes it less likely that your funds will easily be stolen as long as you do not give the hackers access to your account. I say this because Coinbase which is known as the most secure exchange, recently had an incident where a customer on its platform lost $11.6 million in about 10 minutes after falling for a fraudster's trick. Cases such as this are common in cryptocurrency as there are many scammers out there pretending to be from the platform you use or a YouTuber you follow, and because of the lack of regulation, cases like this are more common than in traditional markets. Always ensure that what is being communicated to you is actually from the people and institutions in crypto that you associate with.
The second most important thing is to secure your account on your selected platform. Most platforms always advise that you activate two-factor authentication so that funds will only leave your account when authenticated by you. The only issue here is that if you’re careless, you could unknowingly (or knowingly) compromise your details and this would then give fraudsters access to your account. Therefore, always protect your information. The third most important thing to do to ensure your assets are safe is to transfer your assets to your wallet instead of storing them on an exchange. By doing this, you actually gain full access to your coins by getting your own private keys from the wallet provider, making it less likely that you would lose your coins to hackers. There are two types of wallets, hot and cold. A hot wallet is one that only works when you’re connected to the internet e.g. trust wallet, metamask, etc. and a cold wallet (or cold storage) is one that takes your assets offline e.g. Ledger, Tezor, etc. As with everything else, these also carry some risk but that would be due to human error. Usually, both of these wallets assign to you a unique phrase or set of words which you must immediately store securely upon opening your account and if you lose these phrases, you could lose your account if you ever have to recover it (say on a new device or something). There will be no way to recover these funds outside these phrases and so it is important that you write them down and store them in a secure place that only you know about. Anyone who knows about these phrases can also access your account easily and fully. So, make sure to do your part in securing your assets if you want to use a wallet.
Cryptocurrencies are amazing assets to own but it is important that we are always aware of the risk they possess. Are you exposed to any of these risks mentioned above? If you are then you should take action immediately to avoid losing your precious assets in the future. Although this article touches on these basic risks, there are many more risks that you need to be aware of. Some of which may even be peculiar to only your location. It is very important that you do further research to be aware and understand the whole dynamic.