10 Risks of Investing in Cryptocurrencies

Cryptocurrencies have become increasingly popular in recent years, but they come with a unique set of risks that investors should be aware of. From technological limitations to legal considerations, there are a number of potential pitfalls that investors should be aware of before investing in cryptocurrencies. One of the most critical legal considerations for any cryptocurrency investor has to do with how central authorities view cryptocurrency holdings. This means that individual investors are required to comply with capital gains tax laws when it comes to reporting their cryptocurrency expenditures and gains on their annual tax returns, regardless of where they purchased the digital coins.

Another potential risk associated with cryptocurrencies as a result of their decentralised status has to do with the particularities of transactions. In most other transactions, the physically present currency changes hands. In the case of e-money, a trusted financial institution is involved in the creation and settlement of deposits and credits. Neither of these concepts applies to cryptocurrency transactions.

This issue is also related to the decentralised nature of digital currencies. For example, when a cryptocurrency exchange is hacked and customer funds are stolen, there is often no standard practice for recovering the lost funds. Therefore, investors in digital currencies assume a certain amount of risk when buying and holding cryptocurrency assets. Intangible, illiquid, uninsured - The real miracle of blockchain-based cryptocurrencies, such as Bitcoin, is that the issue of double-counting is resolved without any intermediary, such as a bank or banker.

This feature, captured by the notion of digital singularity, where there can only be one instance of an asset, is powerful and one of the main reasons why this asset class has flourished. However, the intangible and illiquid nature of cryptocurrencies (combined with the previous point about narrow exits) makes their convertibility and insurability difficult. In fact, despite reports of growing insurer interest in the segment, most cryptoassets and crypto companies are underinsured or uninsurable by current standards. There is no deposit insurance "floor" for this asset class, which may help broaden the appeal and security for investors.

Mark To Market - When cryptocurrency holders seek to exit the intangible asset class to return to fiat currencies or other assets, which are often loathed by many cryptocurrency purists, their flight to safety or liquidity most often leads them to the dollar or the United States. However, on exit, this mark-to-market feature causes many investors to come under downward price pressure, highlighting the adverse effects of illiquidity, narrow exits and low participation in the asset class. These types of problems are being remedied as more institutional investors enter the space and more markets and trading platforms open. In the meantime, market participants would do well to be mindful of the inconvertibility of coins and the implied volatility of cryptocurrencies, which would make high-frequency traders shudder.

To truly understand the potential of blockchain, it is necessary to suspend disbelief. To truly grasp the investment thesis of cryptocurrencies requires suspension of the traditional economic yardstick. From extortion to manipulation - While no investor should part with money they are not willing to lose, no matter how nominal the amount, cryptocurrencies are particularly prone to the risks of social engineering and misinformation. The naïve, as in the analogue economy, can become easy prey to cyber extortion, market manipulation, fraud and other investor risks.

The Securities and Exchange Commission (SEC) has gone so far as to create a fake initial coin offering (ICO) website as a way of alerting potential cryptocurrency investors to the threats of "shiny objects". Indeed, emerging regulatory clarity on what constitutes a truly decentralised asset, such as Bitcoin or Ethereum, that is beyond the control of any party versus cryptocurrencies or company-issued tokens is a growing area of focus for securities. Cyber risks on all sides - As with cyber threats which evolve according to Moore's law; the space between keyboard and chair (or smartphone and digital wallet) is as important as cyber hygiene and cryptocustodian defences. Although in principle; Bitcoin blockchain has proven to be one of the most cyber-resistant innovations to date; companies that connect to it like other cryptocurrencies are often new entrants with lax cybersecurity standards and means.

In this sense; not all cryptocurrencies are equal in terms of their traceability; conduct of transactions; and levels of trust or fiduciary responsibility. As such; risks as simple as "mysterious disappearance" and as complex as ransomware attacks and AI-driven bots scouring the internet for weak links and easy prey are complex and rapidly evolving dangers. Getting involved in cryptocurrency markets can expose you to new types of risks; but many believe that cryptocurrencies can bring advantages over traditional financial infrastructure.If you don't have a high tolerance for risk; if you're the type of investor who can fall into a herd mentality that's hard to avoid; or if you don't have a financial or investment advisor to help you make smart decisions; you may want to reconsider whether cryptocurrencies are for you.This volatility risk is due to a number of factors; such as positive and negative news (such as Elon Musk's tweets or threat of regulation) having a strong impact on market prices; as well as large crypto investors needing to sell their position which can "move the market" and change prices significantly given most crypto trading platforms or "exchanges" deal primarily with smaller-scale investors.While there is no doubt that cryptocurrencies; digital tokens; and blockchain-based business models are here to stay; understanding how risks interact with this emerging market and its underlying technologies will not only help protect investors; but also give regulators a steady hand and hopefully guide how entrepreneurs are approaching risk management in their projects which is not easy to do afterwards.Below are 10 examples key risks endangering cryptocurrencies and hindering market's progress:Technological risks - There have been many reports on computational complexity & energy consumption associated with Bitcoin mining; as an example some technological limitations associated with cryptocurrencies.Regulatory risks - Cryptocurrencies which are generally unregulated are high-risk speculative investments which will require regulatory clarity before they can become mainstream investments.Volatility risks - Cryptocurrencies are highly volatile investments due to factors such as positive & negative news having strong impact on market prices & large crypto investors needing sell their positions.Security risks - Cryptocurrency exchanges & wallets have been subject cyberattacks & hacks resulting in loss funds & data breaches.Liquidity risks - Cryptocurrencies lack liquidity due their intangible & illiquid nature making convertibility & insurability difficult.Counterparty risks - Cryptocurrency transactions involve counterparty risk due lack trusted financial institution involved in creation & settlement deposits & credits.Social engineering risks - Cryptocurrencies are prone social engineering & misinformation resulting in cyber extortion; market manipulation; fraud & other investor risks.Taxation risks - Cryptocurrency investors must comply capital gains tax laws when reporting expenditures & gains on annual tax returns regardless where purchased digital coins.Custodian risks - Cyber hygiene & cryptocustodian defences important protect against cyber threats & malicious actors.Reputational risks - Reputational damage can occur due lack regulatory clarity & lack trust from traditional financial institutions.

Faisal Abdul
Faisal Abdul

Extreme internet specialist. Wannabe twitter junkie. Friendly zombie geek. Freelance twitter buff. Professional student. Passionate tv evangelist.

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