5 Risks You Need To Know About Before Investing in Cryptocurrencies
Are you considering adding cryptocurrency to your traditional portfolio? Here are a few critical risks to examine.
Price volatility & manipulation
Cryptocurrencies have been on a wild ride. Epic booms, busts, wild swings, and scams have amazed and baffled investors who have witnessed unexplainable and unprecedented gains and losses over the last decade.
For example, here’s a coinmetrics chart on the volatility of daily returns (14-day average) comparing BTC (Red) to S&P 500 (Teal). Volatility swings in Bitcoin (BTC) and other crypto assets makes it hard for investors (especially retail investors) to build confidence and secure gains.
Volatility in crypto prices generally stems from three primary sources; sentiment, speculation, and market manipulation. It’s the unregulated and anonymous nature of digital asset markets combined with the susceptibility of cryptocurrencies and other crypto assets to sentiment, emotion, and publicity that make prices volatile. Crypto exchanges, media owners, and influential investors can manipulate prices. This manipulation seems to be widespread — albeit not widely proven yet. The most used manipulation strategies include wash trading, dark pool trading, pump and dumps, and shilling.
Lack of regulations
A lack of regulatory frameworks means there is a high degree of uncertainty like price volatility and manipulation. Investors and entrepreneurs are also concerned about the possibility of future restrictions, which may have a significant impact on the value of cryptocurrencies or end up, ultimately banning them altogether.
Crypto regulations are complex, disorganized, and haphazard. One area of particular concern for investors is tax treatment. A lack of regulation or what some term as regulatory greyness means some investors are scared off investing because they don’t have a clear understanding of what tax obligations require consideration or what records must be kept.
The good news is that regulators are catching up. Authorities in many jurisdictions are taking steps, producing research papers, standards and introducing new regulations. Switzerland is one of the first countries to begin building a robust regulatory framework. The country has proposed an idea for minimizing rules while still keeping companies in line with legislation through ‘sandboxes,’ allowing startups to experiment and innovate within controlled conditions.
Britain and Singapore have been exploring their blockchain and crypto regulatory environment as well, providing platforms that enable companies to experiment under relaxed regulation and licensing requirements. In the US, the New York Attorney General’s Office recently launched the most comprehensive study on exchanges.
Market adoption remains low for a host of reasons, from regulatory concerns and technology shortfalls to market volatility, public misunderstandings, and the fact that cryptocurrencies and the underlying blockchain technology that powers them are still emerging and in their infancy. This means there’s a chance that this new asset class, impeded by many different factors, regulations being one of them, will never be broadly adopted, leading to a complete loss of value. There is a clear need for more laws, technology improvements, and institutionalization to help drive trust and scale.
Security, custody & consumer rights
Storing cryptocurrencies and other crypto assets can be risky business. There have been significant incidents of theft on personal wallets but also exchanges. Hacking remains a constant threat if cryptocurrencies are not correctly stored and protected.
To make things worse, investors cannot recover assets that get lost or stolen, and mistaken transactions cannot be reversed. Also, unlike traditional investing through a bank or brokerage, cryptos don’t have official safeguards or insurances. Rebates on lost investments depend on the whim of the organization you’re dealing with.
The good news. Custody solutions that give financial institutions the ability to hold cryptocurrencies on behalf of trading clients are beginning to emerge. These solutions are expected to catalyze the entry of institutional capital into the industry, and in-turn provide a trusted stamp of approval for retail investors as well.
Coinbase has announced its custody product upon completion of their first successful deposit. The multinational investment bank, Citigroup, has announced that it will offer crypto custody solutions to institutional investors. Citigroup launched a product called Digital Asset Receipt, intended for institutional investors to invest in cryptocurrencies in a regulated and secure manner. There is also Fidelity, which has announced a new and separate company called Fidelity Digital Asset Services. The Wall Street incumbent will handle custody for major cryptocurrencies such as bitcoin and execute trades for investors such as hedge funds and family offices.
Exiting the market
The crypto market’s off-ramps are a real problem for many investors. Many exchanges allow withdrawals in USD only, some also allow EUR, GBP, and JPY, but the choice is minimal, and exchanges frequently require high minimum withdrawals when withdrawing to fiat. Many exchanges that support fiat withdrawals also only accept a few leading cryptocurrencies, and to withdraw fiat money, investors need to go through a tedious verification process that can take months. Some exchanges are accused of withholding funds for unclear reasons, and many banks are still very wary of accepting money from the sale of cryptocurrency. All this exposes investors to exchange rates, fees, and risks associated with dealing with opaque exchanges. The situation is improving, but it’s far from ideal.
Originally published at Blockchain Review.
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Anthony is the head of content and research at Intrepid Ventures.
Note: This post should not be considered professional investment advice. If you want to invest in digital assets like cryptocurrency, assess your own personal and financial situation, risk tolerance and consult a financial professional.