Six major risks of cryptocurrency you can't ignore
Investing in cryptocurrency is a high-risk venture. While risk assessment might not be thrilling, it’s essential for your investment safety.
This article outlines six major risks associated with cryptocurrency.
Risk 1: high price volatility
Cryptocurrencies are much more volatile than stocks. Major coins like Bitcoin and Ethereum have seen single-day drops of over 20%, and altcoins can swing even more drastically. This makes cryptocurrencies unsuitable for those with low risk tolerance. Between 2019 and 2021, there were nine days when the total crypto market value fell by more than 20%.
Preventive measures: Set Stop-Loss Limits and Diversify Investments
Risk 2: liquidity issues
Liquidity means trading without major price impact. Some cryptocurrencies suffer from low liquidity, with few active buyers/sellers and wide bid-ask spreads.
Major coins like Bitcoin and Ethereum have good liquidity, but smaller coins are riskier. Entire exchanges can face liquidity crises, like FTX's collapse in November 2022.
Preventive measure: invest in high-liquidity cryptos
Risk 3: frequent security incidents
Fraud and hacking are major issues, causing over a billion dollars in annual losses. Common scams include fake websites, phishing, extortion, and fraudulent ICOs. Exchanges are frequent hacking targets, leading to significant losses, as seen with Mt. Gox.
Preventive measures: increase awareness and diversify asset storage
Risk 4: easy to lose
Crypto wallet addresses are long strings of letters and numbers, making it easy to send funds to the wrong address or lose keys. According to Chainalysis, approximately 17% to 23% of Bitcoin is permanently lost.
Preventive measure: use both hot and cold wallets
Risk 5: legal and regulatory
There are two regulatory risks: restrictive actions by governments that limit crypto use and trading, and inadequate legal protections for investors due to immature regulations.
Preventive measure: stay informed about relevant laws and regulatory updates
Risk 6: platform issues
According to CoinGecko, with over 400 crypto exchanges globally, the top three have a combined market share of 71.7% (June 2024), suggesting poor liquidity in most exchanges. Even major platforms like Binance face technical, security, and governance challenges:
- Technical: Server outages can prevent users from logging in or trading.
- Security: Frequent hacking incidents have led to numerous exchange bankruptcies.
- Governance: Problems like founders running away with funds or exchanges shutting down.
Preventive measure: use multiple platforms
Notable Risk Events in Recent Years
1. Luna/UST Stablecoin Collapse
- Event: In May 2022, UST, a stablecoin pegged to the USD and backed by Terra blockchain's LUNA token, failed to maintain its $1 peg after a massive sell-off. This led to a "death spiral," causing UST and LUNA to crash, with LUNA's price dropping from $119.5 to nearly zero.
- Impact: Massive loss of value and trust in algorithmic stablecoins.
2. FTX Exchange Bankruptcy
- Event: FTX, once the second-largest crypto exchange, went bankrupt in November 2022. A report revealed debt issues at its sister company, Alameda Research, triggering a bank run on FTX. Both entities declared bankruptcy on November 11, 2022.
- Impact: Significant loss of user funds and market confidence in centralized exchanges.
3. Binance Lawsuit in the U.S.
- Event: On June 5, 2023, the U.S. SEC sued Binance, the largest crypto exchange, with 13 charges including operating an unregistered exchange and misleading investors.
- Impact: Legal challenges and increased regulatory scrutiny on major cryptocurrency platforms.
This presentation is for informational and educational use only and is not a recommendation or endorsement of any particular investment or investment strategy. Investment information provided in this content is general in nature, strictly for illustrative purposes, and may not be appropriate for all investors. Read more
