What are the risks of cryptocurrencies nowadays?
Although cryptocurrencies open the door to countless financial and investment instruments, because of the lack of guaranteed value and their digital nature, there are risks that are good to know before you start.
Barry Sibert, CEO of Digital Currency Group (which builds and invests in Bitcoin and blockchain companies) says, “It’s pretty much the highest risk, highest return investment you can make.”
Here are some of the risks one can run into:
Legal risks of cryptocurrencies
Regulatory risks: Bitcoins are a digital rival to government currency and, therefore, can be used for illegal activities, black market transactions, money laundering or tax evasion.
Governments, therefore, may seek to regulate, restrict or ban the use of such currency (some have already done so). Other governments are drafting various regulations on cryptocurrencies.
Tax risk: Cryptocurrencies are a very young technology and market, so government agencies around the world are looking at tax guidelines to deal with different crypto activities. This means that the legal landscape can change rapidly, creating uncertainty about how new or existing tax laws apply to various cryptocurrency activities. It is up to the individual to ensure that he or she pays the tax obligations arising from the purchase or sale of cryptocurrency.
It is critically important to become familiar with the exact tax rules and guidelines of the jurisdiction in which one lives, and to stay abreast of any impending changes to those rules as they are refined over time.
Risks compremising cryptocurrency security
Security risks: Most people who own and use Bitcoins have obtained their currency through one of the many popular online marketplaces called cryptocurrency exchanges. These are entirely digital, so like any other virtual system, they are at risk from hackers, malware and even operational malfunctions.
Hackers can target these exchanges and gain access to thousands of accounts and digital “wallets” where Bitcoin or any other cryptocurrency in the hacked “wallet” wallet is stored.
Users can only prevent these risks by storing their currency on a computer that is not connected to the Internet or by choosing to use a “paper wallet” in which to print the private keys and addresses of Bitcoins without storing them in a computer.
If you are interested in protecting your cryptocurrencies check out this article where I list the best ways to store your cryptocurrencies: How to Keep Cryptocurrencies Safe
Private Key Disclosure Risk: Private keys function as a verification mechanism built into the cryptocurrency wallet, allowing transactions to be signed and sent from the wallet balance. Some wallet providers allow users to retain full custody of their keys, providing only a means to generate a new wallet and interact with it. Other wallet providers manage private keys on behalf of users, providing access through a secure login portal. Finding the right wallet for you can be tricky: both custodial and non-custodial wallets each have their own compromises in terms of security and recoverability.
Anyone who holds a private key for a particular wallet is able to sign transactions as if they were the owner of that wallet, so these keys must be kept extremely secure. Typically, cryptocurrency wallet providers will ask you to keep a backup of your keys in a secure location in case you should lose access to your wallet. It probably goes without saying, but private keys should not be shared with anyone or publicly exposed in any way.
Hardware cryptocurrency wallets, such as those offered by Ledger and Trezor, are popular options among cryptocurrency holders today, as they allow users to store their private keys on a device that remains offline and is less exposed to potential attackers.
Remember that the responsibility for keeping your private keys safe is yours alone. Be sure to choose a secure wallet and an appropriate backup method, and avoid storing private key backups on an Internet-connected device.
Insurance Risk: Currently, cryptocurrency exchanges and wallets are not insured by any federal or government programs.
In 2019, the trading platform (SFOX) announced that they would provide Bitcoin investors with insurance, but limited only for cash transactions.
Fraud risk: Bitcoin uses private key cryptography to verify owners and record transactions, but fraudsters may try to sell fake Bitcoins, However, due to Bitcoin’s security architecture, this transaction can only receive a maximum of 2 confirmations.
Cases of price manipulation, another common form of fraud, have also been documented.
Market risk: as with any other investment, Bitcoin prices can fluctuate. In fact, the value of Bitcoins has fluctuated wildly since 2009.
Environmental impact: The technology uses huge amounts of electricity, resulting in a high environmental impact. It is estimated that bitcoin’s energy consumption is equal to that of a small country.
Let’s not forget the huge competition for bitcoin, and that a technical innovation in the form of a better virtual currency is always a threat.
If you are looking to invest in cryptocurrencies through an ICO (Initial Coin Offering), you should ask yourself the following questions:
- Are there already other major, well-known investors in the cryptocurrency world?
- Will you own a stake in the company or just currency or tokens? The former means that you will actually own the company, while the latter will only give you cryptocurrency to buy or sell.
- Is the currency already developed or is the company trying to raise funds to develop it? The more advanced the project, the less risky it will be, but the sooner you cross over, the more profit you will get, but the risk also increases.