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Risks of investing in crypto

Lesson in Course: Crypto (advanced, 5min)

All investing involves taking risk. What do we need to know to protect ourselves when investing in crypto?

Eureka!

What it's about: There are unique risks investing in crypto because it's still in its early stages.

Why it's important: Investing in crypto is similar to investing early in a start-up company.

Key takeaway: It's a good idea to start slow, see how regulations develop, rather than putting all of our money in at once.

Cryptocurrency as an asset class is still in very early stages. Since the utility and value of the crypto are evolving, wild price fluctuations are common. After all, investing in crypto now is similar to investing in the very early days of Facebook — there's a chance it can turn into a tech juggernaut, but there's also a chance it can go the Myspace route.

Key risks as an asset class

To address the uncertainty, let's consider some of the biggest risks facing crypto.

Regulatory

Every government around the world has different policies toward the adoption of crypto, allowed use, and taxation of gains made from investment and trading. Even as government positions form, the inconsistencies between regulators and crypto's legal status create concerns about widespread adoption.

China, Russia, and Vietnam have all banned crypto

Some jurisdictions classify crypto as an asset while others see it as a currency, leading to different tax treatments depending on where we live. Regardless of what lawmakers decide, crypto's growing appeal is making it harder to dismiss.

Crime

The association of crypto with criminals is an ongoing concern. The decentralized nature allows cybercriminals and terrorist organizations to receive ransom while staying somewhat anonymous.

Ransomes are often demanded in crypto

For this reason, some countries put restrictions on rights to acquire, own, hold, sell, or use crypto. Being tied to crime presents significant headwinds for the general use of crypto until anti-crime technology is developed.

Faulty memory

If we decide to use our own crypto wallets and trade on decentralized exchanges, we will be responsible for the security of our private keys and seed phrases. If we forget them or they get stolen, our coins are likely lost forever. 

Missing Bitcoin

Hundreds of billions worth of Bitcoin has been locked by people who forgot their key! Some services will help us try to recover lost keys so that we can reclaim our crypto.

Read the whole storyhttps://www.nytimes.com/2021/01/13/business/tens-of-billions-worth-of-bitcoin-have-been-locked-by-people-who-forgot-their-key.html

Speculation and Volatility

Cryptocurrencies are still highly speculative, and prices for most coins are not stable. 

In times of exuberance, increasing prices drive a speculation frenzy

The prices of crypto move dramatically daily, often triggered by news headlines or celebrity tweets. Many folks buy crypto based on the hope that the price will increase rather than on any intrinsic value. For many cryptocurrencies, the majority of the coins have never been used for buying things. This can create an emotional rollercoaster, making it hard to stay a rational investor.

Liquidity

There are liquidity issues with smaller lesser-used cryptocurrencies on decentralized exchanges. 

A sudden drop in demand can be disastrous for the price

With fewer folks in these networks, it's harder to buy and sell coins. This could lead to bigger losses if there is an abrupt drop in value or an inability to swap to another coin.

 

Actionable ideas

Investing in crypto is similar to investing in an early-stage company, filled with high risks and lots of uncertainty with a potential for losing your entire investment. However, an investment this early could have a bigger payoff later. If you want to buy some crypto, starting slow and watching how regulations and which blockchains become more developed will help mitigate the risk of overinvesting and losing lots of money if things don't work out. 

 

Supplementary materials

Here are a couple of videos raising some additional concerns about the speculation and fanaticism in Bitcoin.

From the first peak in 2018:
https://www.youtube.com/watch?v=MSpWAYwqXQ4&ab_channel=ThePlainBagel
From the second boom in 2021:
https://www.youtube.com/watch?v=t2H0EKnkLqk&t=16s&ab_channel=ThePlainBagel