4 Major Cryptocurrency Risks and How to Avoid Them
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Crypto investing has its risks, due to extreme price volatility, it is highly susceptible to sudden losses or gains. Additionally, there is a lack of regulation and security concerns such as hacking and fraud. There could also be underlying issues with the technology behind cryptocurrency projects. Any of these reasons could potentially cause your holdings to evaporate into thin air.
In this article, I will cover all the key issues to provide you with comprehensive information about the risks involved. Should you find it helpful, there is also an article; 11 ways to make money in crypto that features a risk rating from 1 to 10 for each method of investing in the crypto market as a guide.
1. Volatility
If you happen to buy a cryptocurrency when its price is very high—often after a period of continuous price increases known as a bull run—you could experience a major drop in value if the market turns downward for an extended period. In the crypto world a major drop is called a crypto winter, which so far occurs around once every 4 years.
In this case, you could potentially lose a significant portion of your investment—potentially up to 90%. No institution is going to cover your losses for your crypto investment; you take on all the risk. As a result, you will need to carefully assess your risk tolerance and only invest money that you’re prepared to lose, as the market’s extreme volatility can lead to unpredictable outcomes.
So far, all cryptocurrency coins tend to follow Bitcoin’s price patterns. At the start of a new bull run, Bitcoin’s price increases, pulling other coins along for the ride. However, not every four-year cycle unfolds the same way. While Bitcoin and Ethereum consistently see price increases, there are always other coins that outperform, delivering gains that surpass even Bitcoin’s.
Each cycle features a select group of these outperforming coins, which change every four years. The challenge lies in knowing when to exit the market after a substantial bull run to avoid the massive 90% drops that often follow in the crypto market.
If you want to avoid losing significant gains, the safest cryptocurrencies are always Bitcoin and Ethereum. Plus, timing your purchase when prices are at their lowest in the four-year cycle can greatly benefit your portfolio.
2. Security Concerns
Security concerns such as hacking and fraud are a big risk in the crypto world. A well-known example is what happened to the Squid Game (SQUID) token scam back in 2021. Investors were drawn into the scam coin which got rug pulled, with promises of a play-to-earn game.
The token’s creators imposed restrictions on selling SQUID tokens, causing the price to soar while preventing most investors from cashing out. After the token reached a peak price, the developers abruptly sold their holdings, crashing SQUID’s value to near zero and disappearing with an estimated $3.3 million in investor funds.
Keeping your cryptocurrency on a third-party exchange poses a security risk due to the potential for the platform to be hacked. One prominent example is the Mt. Gox hack in 2014. Mt. Gox was a major cryptocurrency exchange based in Japan that handled over 70% of global Bitcoin transactions at its peak.
In a series of hacks over several years, approximately 850,000 Bitcoins were stolen, valued at around $450 million at the time. This caused the exchange to file for bankruptcy, and many investors lost their funds, with only partial repayments being offered years later.
This hack is often cited as a cautionary tale about security vulnerabilities in cryptocurrency platforms.
A small selection of cryptocurrency exchanges have some good security measures like Kraken, which we have outlined in the Kraken Review. There are also exchanges that have insurance to cover customer funds should a hack occur. However, it may take long to get your funds back. Plus, regardless of the extensive security measures taken by the exchange, the best approach is always going to be to avoid third parties altogether by cold storing your own crypto using a hardware wallet.
To avoid rug pulls, you would need to do your own comprehensive research before investing in a cryptocurrency. Most investors would not have the know-how on what to research to ensure they do not get scammed. This is where you will need to rely on professionals you can trust to do background checks on your behalf before you invest.
I wouldn’t know who to suggest for advice on most of the cryptocurrencies investors might be interested in. However, I am subscribed to The Crypto Vigilante guys and Real Vision and follow their suggested cryptocurrency picks to reduce my risk.
3. Technology Issues
The technology behind cryptocurrency projects could also be an issue, especially for the ones that are relatively new and unproven long-term. One such example is the collapse of Terra’s LUNA cryptocurrency in 2022, which was primarily due to the failure of its algorithmic stablecoin, TerraUSD (UST), which was designed to maintain a 1:1 peg to the US dollar.
When UST lost its peg, the system attempted to stabilise it by issuing more LUNA tokens, leading to hyperinflation and a dramatic drop in LUNA’s value. The interconnected nature of LUNA and UST created a feedback loop, and as confidence in UST’s stability eroded. Both tokens rapidly plummeted, from over $120 per coin to zero. LUNA’s $50 billion market cap market cap got wiped out and led to $400 billion in total losses to the wider cryptocurrency market.
I personally got caught up in this and watched my LUNA holdings evaporate from just over €3k to zero in just a few days. I could have sold my LUNA, but I clung to the false hope that the price would recover, which never happened.
What made it even more baffling was that so many people believed in LUNA—some of them were seasoned crypto experts who should have known better but still got caught out.
Do Kwon, the co-founder and CEO of Terraform Labs who created LUNA and TerraUSD faced lawsuits and investigations worldwide. For months, Do Kwon’s location was unknown, but he eventually was arrested in Montenegro.
This experience is a harsh reminder of how unpredictable the market can be. Today, seasoned crypto investors are more cautious about what cryptocurrencies they promote, especially after the backlash from investors that listened to their recommendations. However, mistakes can still be made. It underscores the importance of diversifying your investments and spreading your risk rather than putting all your eggs in one basket.
4. Lack of Regulation
Since cryptocurrency is still relatively new and governments have been slow to respond to the industry, the lack of regulation poses several risks. Whether this is seen as a positive or negative depends on your perspective.
One major concern is the lack of investor protection. Regulatory frameworks often include mechanisms such as insurance funds or the ability to file complaints, which help protect investors. Without these, individuals have little recourse if they fall victim to scams or exchange failures.
It could be argued that with bloated and corrupt governments, even with supposed investor protections, the level of protection may be minimal. Authorities may not always act swiftly or effectively to safeguard consumers.
Another risk is market manipulation. In an unregulated environment, large players can manipulate the market, creating artificial price movements and volatility that can lead to significant losses for smaller investors.
The absence of regulation also means there is no standardized framework for operations, resulting in inconsistent practices across platforms and projects. This inconsistency makes it difficult for users to compare services and understand the associated risks.
Lastly, the lack of clear rules creates an environment of uncertainty, where the legality of certain cryptocurrency activities can be questioned. This can lead to sudden policy shifts or government actions that may have a negative impact on the market.
Unfortunately, there is nothing you can do to mitigate the risk of legislation affecting your portfolio. However, keeping a watchful eye on the news may give you some advance warning of potential legislation that could be rolled out in future that could impact your investment.
Conclusion
In conclusion, while cryptocurrency offers exciting opportunities, there are significant crypto risks that investors should be aware of. Price volatility, regulatory uncertainty, security concerns, and underlying technological issues all play a role in shaping the market.
Understanding these risks and approaching crypto investments with caution can help you make more informed decisions. As with any investment, thorough research and a clear strategy are essential to navigating the complex landscape of cryptocurrencies safely.
