Crypto market is definitely one of the most volatile asset classes today. The market crashes of the year 2022, have been enough proof to show how companies and currencies that were once priced extremely high and held a significant value, collapsed and became worth almost nothing.
This has highlighted more than ever the importance of doing a thorough research and making sensible choices while managing cryptocurrencies.
Having said that one fact that stands true and cannot be denied is that the crypto market is one of the most lucrative ones out there.
Despite the risks associated the potential for growth is massive, especially as more and more sectors and multi billion dollar companies move ahead with the adoption of cryptocurrencies.
The popularity of cryptocurrencies is growing at a rapid rate among the common masses. As more people come around to using crypto for daily mundane activities and transactions, it could drive up the prices by increasing the demand significantly.
In fact, many experts are also of the opinion that some governments around the globe might actually start recognizing cryptocurrencies in 2023. This would be consequential in seeing more regulation and in turn greater legitimization of digital currencies.
Let’s take a deep dive into what are the associated risks and benefits of investing in crypto currencies so that you can make a better and more informed decision.
What are the Risks associated with investing in cryptocurrencies?
As has been mentioned several times before, the crypto industry is a very risky one. Prices fluctuate drastically, and things can take a turn for the worse or for the better at any time.
Laith Khalaf, who is a financial analyst at AJ Bell
There is a dark underbelly lurking in the figures, which suggests there is still potential for widespread consumer harm. The fact that 14% of crypto buyers have borrowed to invest is simply terrifying. The extreme volatility and uncertain long-term outlook for crypto means holdings can be wiped out, leaving borrowers with nothing but their debt as a memento.
Also read: Things to know before investing in cryptocurrencies
Major Risks Involved in Investing in Cryptocurrencies
Volatility
We have said this multiple times before. Still, nothing is enough to emphasise that Cryptocurrencies are highly volatile and their prices can go up or down quickly, making them a risky investment. Let’s take an example of the very popular FTX crash. The exchange was touted to be one of the best in the market and was ranked third globally.
Just within a matter of a few days in November 2022, the entire exchange collapsed, the value of the Native token FTT dropped drastically, and the owner SBF, who was once worth 26 billion dollars, now had almost nothing with him.
This goes to show just how volatile the industry can be and a token whose price soars high one day could drop down dramatically the next.
Regulatory Uncertainty
The second major drawback of crypto currencies is that the lack of regularity brings in a lot of uncertain developments. In regulated investments, buyers would get support from the Financial Ombudsman Service or the Financial Services Compensation Scheme if they were mis-sold crypto or the provider went bust. This wasn’t the case when it came to crypto.
Being unregulated assets, they aren’t covered by the common safety nets. In my own experience, many of my friends and family members have fallen prey to the several Ponzi strategies, and pyramid schemes in the crypto industry and due to lack of regulation haven’t received any reimbursement.
Security Risk
Crypto exchanges and platforms can be easily hacked, and due to this investors could end up losing all their funds and investments. Since it is all online and based on the internet, hackers can exploit the resources. Even the most reputed and popular platforms could fall victim to these hackers.
For example: 45MUSD worth of Kucoin hack.
We all are aware of the Kucoin exchange. Despite being the ones of the top and recognised exchange in the world, hackers were able to hack and withdraw funds.
Lack of Liquidity
Liquidity is nothing but the ease with which selling or buying can be done without affecting the market prices. Crypto markets unfortunately provide fragmented liquidity.
This means that owing to the relatively new nature of crypto as an investment vehicle, there is often limited liquidity in the market which makes it difficult to buy and sell large amounts at once without significantly affecting the price of the cryptocurrency being traded.
Liquidity fragmentation happens between different platforms. Due to this factor, the global price discovery becomes next to impossible.
Fraud and Scams
Another issue that is plaguing the crypto market today is the risk of fraud and scams. Many groups and individuals exploit vulnerable and naive users and entrap them with their schemes.
Being beginners who are new to the market, these users lack the ability to differentiate between the legit platforms and the fraudulent sites and schemes, and as a result, get swindled into losing a lot of funds.
The most common types of scams today include the following: Investment Scams, Phishing Scams, Upgrade Scams, SIM-Swap Scams and finally fake Crypto Exchanges and Crypto Wallets.
We have covered the brief details about these scams ahead in the article. Hence you should be extremely vigilant and careful in order to stay safe and protected from these scammers.
Since crypto is out of a lot of legal jurisdictions, the law enforcement agencies can proved only limited aid. However, if you do come across any such crime or con trick you must make sure to report it. You can do so using the following platforms:
- Federal Trade Commission
- Securities and Exchange Commission (SEC)
- Commodity Futures Trading Commission (CFTC)
- Internet Crime Complaint Center (IC3)
Tax Implications
The last but definitely not the least factor to see is the tax implications.
Cryptocurrencies are subject to taxation in some jurisdictions, and investors should be aware of these implications before investing.
As of now in India, there is a tax of 30% plus a surcharge and cess implied on any transfer of VDA for example Bitcoin or Ethereum. This comes under the Income Tax Act of 1961 (Income Tax Act).
Obviously different countries have different rules and regulations applicable to the crypto market and hence you must be aware of the policies that are under effect in your country of residence.
Why are cryptocurrencies so volatile?
Cryptocurrencies are highly volatile because they are relatively new investments with limited liquidity and a lack of regulation.
Additionally, the speculative nature of cryptocurrencies can lead to large price swings as investors buy and sell them in search of profits.
Finally, news related to cryptocurrencies can have an outsized effect on their prices due to the small size of the market.
The best thing to do in crypto is not to invest at one go. Instead follow the DCA approach.
What are some of the scams and security risks associated with cryptocurrencies?
We earlier mentioned in the article some of the security and scam risks linked with the crypto market.
Let’s have a look at the various types of these risks and frauds:
Phishing Scam
In a phishing scam, the fraudsters try to get their hands on your account details as well as your crypto keys. This can be achieved through creating fake and fraudulent websites, impersonation of reputed companies, etc.
Upgrade Scams
An upgrade scam is done in the disguise of software updates. Scammers can trick you into submitting your private keys in the name of a software update and hence get access to your funds.
SIM-Swap Scams
A SIM-Swap Scam is s more complex mechanism hackers use to scam users. Through this method, they can get a copy of your SM card and can access all the data on your phone.
When this happens they can have their hand on the two factor authentication code, the one time passwords, and other confidential data that may be residing on your device.
Investment Scams
Investment Scams are pretty straightforward. In these schemes, the perpetuator makes up policies and fraudulent schemes like that offer users massive profits. For example, there are projects that talks about 1% profit everyday (which looks too good to be true).
Through this, they entice users to invest a huge sum of money that in the end goes down the drain and doesn’t bring anything for the user.
Read about BlockAura TBAC Scam.
Exchange Hacks
Cryptocurrency exchanges can be hacked, which means investors may lose their funds if they are not adequately protected from cyber-attacks.
Wallet Theft
If an investor’s wallet is not secured properly, it could lead to the theft of their funds by malicious actors.
Fraudulent ICOs
There have been numerous cases of fraudulent Initial Coin Offerings (ICOs) where investors have lost money due to false promises made by the project developers or other malicious actors.
Smart Contract Errors
Smart contracts are used to facilitate cryptocurrency transactions, and errors in these contracts can lead to the loss of funds for investors.
Pump-and-Dump Scams
This is when scammers artificially inflate the price of a cryptocurrency with false or misleading statements then sell it for a profit, leaving other investors with devalued tokens.
Malware Attacks
Malicious software can be used to steal cryptocurrencies from wallets or exchanges, so investors should always keep their devices secure with up-to-date antivirus software.
Also read:
What happens to the cryptocurrencies you hold if there is a lack of liquidity?
If there is a lack of liquidity in the cryptocurrency market, it can be difficult to buy and sell large amounts without significantly affecting the price of the cryptocurrency being traded, which could cause prices to drop sharply, resulting in losses for investors who are holding that particular cryptocurrency.
How to safeguard yourself from Cryptocurrency Fraud and Scams?
To safeguard oneself from cryptocurrency fraud and scams, it is important to do one’s own research before investing in any digital asset. One should make sure to understand the project’s technology, team, roadmap, and use-case before investing.
Additionally, one should only invest what they can afford to lose and never send money or personal information directly to anyone over the internet.
Finally, one should store their cryptocurrencies in secure crypto wallets with two-factor authentication enabled.
Can all cryptocurrencies go to zero?
No, not all cryptocurrencies can go to zero.
While some may become worthless in the future due to lack of demand or other factors, there are many that have a strong foundation and community backing them, making it less likely for them to become worthless.
However, it is important to remember that all investments carry risk and any cryptocurrency could potentially lose its value over time. A real life example can be taken from what happened to Terra Luna in 2022. It once stood as one of the t0 most valuable cryptocurrency in the world and became zero in its value.
Many people who had their life’s savings invested in Terra Luna had to face huge losses and all their funds were left not being worth a penny. Another example of one of the early fraudulent coins that turned zero value was OneCoin, ran by Cryptoqueen, which emerged as a $4 billion Ponzi scheme.
Is investing in cryptocurrencies illegal?
No, investing in cryptocurrencies is not illegal. However, it is important to note that cryptocurrency regulations vary from country to country, and investors should research the legal implications of investing in their particular jurisdiction before making any investment decisions.
Let’s also have a look at staking which is also one of the major ways users can use crypto to make money. From a legal standpoint, staking is completely legal as long as you make sure that are complying with the anti-money laundering, KYC and taxation regulations that are applicable in your country.
As mentioned, the legalities of crypto and related digital assets vary from country to country. In places like El Salvador and the Central African Republic the Bitcoin token is acknowledged as a legal tender which makes them the only two countries to do so.
Over 131 countries of the likes including the US, the UK and other European nations have taken steps and recognised the legal status of crypto for investment, trade, and payments. Canada and UAE are part of 15 countries that have allowed users to trade cryptocurrency but put restrictions on financial institutions on conducting such transactions.
On the other hand countries like China, Nepal, and Egypt have a complete ban on anything to do with crypto.
What are the benefits of investing in cryptocurrencies in 2023?
The benefits of investing in cryptocurrencies in 2023 include:
Potential for High Returns
Cryptocurrencies have the potential to generate high returns over time, as they are still a relatively new and emerging asset class. You can stand a chance to make big sums through crypto if you invest in the right places, and these returns are unparalleled to many other investment options in the market today.
A common phrase of “high risk, high returns”, is quite applicable when it comes to crypto. Hence your returns are often determined by your risk appetite and how much are you willing to put in.
Accessibility
Cryptocurrencies can be bought and sold from anywhere with an internet connection, making them more accessible than traditional investments such as stocks or mutual funds.
This invariably democratizes the investment process and makes it available to everyone. You can manage your crypto from anywhere and not be restricted my the perils of locations and other limitations.
This is a boon to those who need to be constantly moving for work or personal needs and hence don’t end up losing their funds.
Decentralization
Cryptocurrencies are decentralized, meaning that no single entity controls the market or sets its prices, allowing investors to make their own investment decisions without being influenced by external forces.
With paper money, the central authority, which is inherently the government, controls its supply and circulation. This means that as long as the government is stable, the people trust the currency.
In such a system, the value of money, an infinite resource, is inverse to the amount of money printed. Hence, an ideal currency situation must be limited and decentralized.
Here is where crypto currency comes into play as it performs transactions without the involvement of an intermediary body.
Low Transaction Fees
Cryptocurrency transactions typically have much lower fees than those associated with traditional payment methods, allowing investors to save money on transaction costs.
Diversification
Investing in cryptocurrencies can provide portfolio diversification and help reduce risk by having exposure to an asset class that is uncorrelated to the stock market or other investments.
Anonymity
When we talk about blockchain, which is the major asect behind crypto, an important aspect that must be mentioned is the characteristic of anonymity. Through cryptography and blockchain, cryptocurrency ensures safe, private, and anonymous transactions to its users.
Independent and Immutable
The sense of immutability becomes one of the biggest pros of cryptocurrency. As discussed before, the ownership of the currency is shared. It is not under the control of a mediating authority, where the asset value is unaffected by the political climate and your data is tamperproof. Crypto currency is independent of inflation. The value of crypto doesn’t change with inflation patterns, owing to its limited nature.
How to know if you should invest in Cryptocurrencies?
You should invest in cryptocurrencies if:
- You are comfortable with the high volatility and potential risks associated with investing in cryptocurrencies.
- You have done your research and understand the technology behind the cryptocurrency you are investing in.
- You have a long-term investment strategy and are willing to hold your investments for the long-term.
- You are comfortable with the fact that cryptocurrencies are not backed by any government or central bank.
- You are comfortable with the fact that cryptocurrencies are not insured by the FDIC or any other government agency.
- You are comfortable with the fact that cryptocurrency transactions are irreversible.
What are some of the top cryptocurrencies to buy as a noob?
If you are a beginner you might be confused about which cryptos are lucrative options to invest your money in. As per our opinion, some of the top cryptocurrencies to buy as a noob include Bitcoin (BTC), Ethereum (ETH), Litecoin (LTC) and Binance (BNB).
These are all established digital assets with strong communities backing them, making them a good choice for new investors.
Other popular options include Cardano (ADA), Polkadot (DOT) and Uniswap (UNI).
Here are some posts that can help:
- Top Cryptocurrencies to hold for Long Term
- Best Cryptocurrencies to buy in the Bear Market (Binance and Kucoin)
- Top Cryptocurrencies under 1USD for 2023
But as always, do your own research.
FAQ
Should I invest all my money in cryptocurrencies?
No, investing all of your money in cryptocurrencies is not recommended. Cryptocurrencies are a high-risk investment and it is important to diversify your investments across different asset classes. Investing only a portion of your portfolio in cryptocurrencies can help reduce risk while still providing the potential for growth.
Should I sell my house and invest in Bitcoin?
No, selling your house and investing in Bitcoin is not recommended. Investing all of your money into a single asset carries a high degree of risk and should only be done after conducting thorough research and understanding the risks associated with such an investment.
What are some tips for investing in cryptocurrencies?
Do Your Own Research
Make sure to conduct thorough research on the technology, team, roadmap, use-case and market sentiment of any cryptocurrency before investing.
Diversify
Spread out your investments across different types of digital assets to reduce risk while still providing potential for growth.
Set Limits
Decide how much you are willing to invest in each cryptocurrency and stick to it so that you do not overextend yourself.
Use Secure Crypto Wallets
Store your cryptocurrencies in secure wallets with two-factor authentication enabled to help protect against theft and fraud.
Track Regulations
Stay up to date on any changes in regulations related to cryptocurrencies so that you can adjust your investments accordingly.
The Main Takeaway
Crypto can be rewarding, but it can also be brutal. It can take your wealth in less than a second, if you are careless.
The main thing to keep in mind before entering the world of crypto is learn about it. If I were to invest in crypto in 2023, I would spend atleast one week learning about it.
Then you need to start with a very small amount. Follow the crypto trends, attend some blockchain events, join some facebook/telegram groups. Observe!
Once you are comfortable, then start making your long term goal and what you want to achieve from crypto in long term. Start analysing your own requirements. You must carefully assess what are your investment goals and how much are you ready to put into the game from a financial point of view.
I recommend not investing more than 10% of your net worth in cryptocurrencies.
Only through well informed and well calculated decisions will you be able to make the most of your invested funds. You need to understand the market trends, your own investing capacity, and the various regulatory policies associated with Bitcoin and other cryptocurrencies.
You must keep in mind the age old saying of “don’t write checks you can’t cash” and be extremely cautious when dealing with cryptocurrency.
