Cryptocurrency has been around for approximately 11 years now when Bitcoin first hit the scene, and though the initial boom of excitement has faded somewhat, it remains a popular investment choice for many individuals looking to supplement or diversify their financial portfolios. Some are even adding cryptocurrency assets into their retirement portfolio in pursuit of growth and to produce extra income for their golden years.
Cryptocurrency still has exciting potential, and it is a relatively easy form of investing, even for those without much knowledge going into it. But it is not without its pitfalls, and understanding the risks of cryptocurrency investing is an important thing to consider when purchasing cryptocurrency yourself.
What Is Cryptocurrency?
In simple terms, cryptocurrency is a type of digital currency that is made secure using cryptography, most commonly blockchain technology. It differs from both traditional currency and electronic currency in many ways, making its use somewhat confusing for many people.
Cryptocurrencies can exist without the backing of a central governing body, which makes them theoretically free from manipulation by a federal government or similar agency. That is one aspect of cryptocurrency’s use that appeals to many. Its use of cryptography allows for transactions to be extremely secure and less vulnerable to fraud and hacking, unlike banks and other institutions which use a central agency for control and accuracy. At this time, the leading crypto names are Bitcoin, Ethereum, Ripple, Litecoin, and Theta, and the market values of these five ranges from $200 billion for Bitcoin to approx.. $600 million for Theta. These different cryptos have different functions and use.
What makes cryptocurrency riskier than some other types of investments is the newness of the industry. With cryptocurrency still a newcomer in the world of finance, its regulation is not as established as other forms of financial services.
The legal status of cryptocurrency has different definitions in different areas. Depending on where you are located, it can be considered an asset, a product, money, or property. Even though cryptocurrency has been in the picture for around 10 years, regulation of the industry is not fully established and is the subject of much debate.
In the United States, various government agencies are still fighting for control; the US Securities and Exchange Commission sees cryptocurrency as a security, the Internal Revenue Service views it as property, and the Commodity Futures Trading Commission thinks of it as a commodity.
Due to the lack of consensus on both defining cryptocurrency and regulating it, cryptocurrency can be a risky investment. Its longevity is not yet established, and many places still do not accept cryptocurrency as a valid form of payment.
The cryptocurrency market is volatile, and quick shifts can lead to sudden gains or losses with very little warning. It is not out of the question for cryptocurrencies to suddenly rise or drop by hundreds or even thousands of dollars within hours. And with new types of cryptocurrency entering the market regularly, there is always a risk of discontinuation or a hard fork, which is a radical change to a protocol in a network that makes a transaction and blocks valid or invalid. Hard forks can often trigger substantial price volatility around that event, another risk for investors. To invest in cryptocurrency, you need to be prepared to deal with extreme fluctuations in price and the loss of potentially thousands of dollars at a moment’s notice. Of course, the reason why you might consider devoting a small portion of your growth portfolio to cryptos is because they also offer explosive upside potential, and many people still recall the significant number of new “crypto millionaires” from the big run-up in 2016-2017.
Limited Trading Opportunities
Unlike other types of investment assets, cryptocurrencies can only be traded in a limited number of venues, just like stocks. Generally, if you want to purchase or sell a cryptocurrency, you must do so through a cryptocurrency exchange, as you do with stocks. Depending on the type of cryptocurrency you are looking for, your choices might be even more limited. Some cryptocurrency exchanges cater to only a few cryptocurrency types, so if you have a more obscure type, selling it could be difficult.
Because cryptocurrency is an online asset, it can be vulnerable to hacking and fraud if you are not careful. Scams using cryptocurrency are abundant, and exchanges that support trading of cryptocurrency are vulnerable to being hacked. If that happens, your cryptocurrency might simply be gone, and you will have little to no recourse available to get it back. For this reason, many investors who buy and hold cryptocurrency use a ‘cold storage’ option, also known as a digital wallet, in which you can store cryptocurrency offline in a secure device.
Consider Your Risk Tolerance
Any good financial advisor will likely tell you never to invest more money than you can afford to lose, and this is especially true when it comes to investing in cryptocurrency assets. Because of the high volatility of the market, your level of risk will also be relatively high. Carefully consider your risk tolerance before investing in cryptocurrency and be sure to consult a financial professional if you are not certain about how to proceed. The more diverse your portfolio, the more secure your investments are likely to be, so you should invest only a small portion of your assets in cryptocurrency. That will protect you from any significant fluctuations and volatility in the cryptocurrency market while still offering you a chance to make a profit, as the adoption of various cryptocurrencies in the economy and daily commerce grow.