Understanding Cryptocurrency Risks
The risks involved in cryptocurrency should not be ignored. Before considering it as a viable investment alongside or instead of more traditional forms of investing, it is important to educate yourself on the potential dangers involved in buying cryptocurrencies.
There is no doubt that cryptocurrencies have become a major part of the financial sector, acting as a growing alternative to more traditional forms of investing.
So popular have the likes of Bitcoin, Ethereum and Ripple become that, according to a study by NerdWallet, almost a third (31%) of 18- to 24-year-olds would rather invest in cryptocurrency than save into a workplace or personal pension. In many cases this is because of the perceived risks involved in investing in pensions, with over a quarter (26%) of young adults saying that they were reluctant to save into a pension because they felt it was too risky.
Understanding cryptocurrency risks, however, is just as important a step to take before you consider investing in such products.
Below we cover the possible dangers to bear in mind when investing in cryptocurrencies, including their volatility, susceptibility to hacking, and the costs of human error.
Even someone with little knowledge of cryptocurrencies will likely be aware of how volatile they can be.
Huge price swings have become part and parcel of the cryptocurrency landscape. Between July and October 2021 alone, Bitcoin traded both below £22,000 and above £48,000.
These boom and bust periods can make it very hard to predict the long-term price performance of cryptocurrencies.
And while that is true of any investment, the scale of the volatility seen in the cryptocurrency sector and the tendency for prices to move for dubious reasons – as a result of tweets posted by Tesla’s Elon Musk, for example – means you must keep in mind how sharp and sudden losses in crypto value can be.
When buying cryptocurrencies, you bear more of the responsibility for the storage of your assets than you would with other investments.
You will store your cryptocurrencies in a digital crypto wallet, encrypted with a private key.
Since these private keys are extremely long, you will also be given a 12 word phrase known as a seed phrase, which can be used to recover funds and access your wallet. If you forget this phrase, or lose your copy of it, your cryptocurrency assets will very likely be lost forever.
This means investing in cryptocurrencies can leave you at the mercy of human error, which is no small thing.
The aspects of cryptocurrency storage that make them prone to human error are also what make them in danger of hacking and other security breaches. In August 2021, for example, $600 million (£433 million) in cryptoassets were stolen when the Blockchain site Poly Network was hacked.
Digital crypto wallets, such as mobile and desktop apps, are also called ‘hot wallets’. This means that, while they are easily accessible as they are stored online and are heavily encrypted, the internet connection required means they are not 100% safe from hackers.
Other forms of crypto wallets are called ‘cold wallets’, and act as offline storage systems. Cold wallets usually come in two forms:
- Hardware wallets that can be plugged into your computer, but exist offline
- Paper wallets, where you write down the private key and public address of your crypto wallet.
Both forms of cold wallet, however, carry the risk of being lost or damaged, meaning you will lose your cryptoassets forever if you do not have a back-up.
It is recommended that, if you are to invest in cryptocurrencies, you use hot and cold wallets in tandem.
At present, cryptocurrencies are largely unregulated and decentralised (although if global governments have their way, this may change in the future). In fact, for many, that is their biggest appeal.
Yet this also leaves investors without regulatory protection in the case of theft and hacking, and at risk of encountering cryptocurrency scammers. Due to this, and the extreme price swings possible in crypto, the Financial Conduct Authority (FCA) even goes as far as saying that investors should be prepared to lose their entire investment.
Due to the lack of robust FCA regulation in the sector, there are a number of different cryptocurrency scams potential investors can fall foul of.
These can range from fake celebrity endorsements, to phishing emails, fraudulent cloud mining platforms, and ‘exit scams’, where a new cryptocurrency is created, only for the early investors to run away with the funds.
» MORE: Cryptocurrency scams explained
Environmental concerns of cryptocurrency
While not a risk of the same ilk as the dangers mentioned above, the environmental impact of cryptocurrencies is arguably the most important factor to consider before you decide to invest.
The minting process for many cryptocurrencies is very energy intensive, to the point that the carbon footprint of Bitcoin alone is comparable to that of entire countries.
Although the environmental impact may not affect you directly, or at least not yet, it is an unavoidable part of weighing up whether or not to invest in cryptocurrencies.
WARNING: Cryptoasset investing is unregulated in the UK, high risk and speculative. Capital is at risk and your entire investment can be lost. We cannot tell you if any form of investing is right for you. Depending on your choice of investment your capital can be at risk and you may get back less than originally paid in.
Research methodology: The research was carried out in September 2021 for NerdWallet by market research company OnePoll. Ten questions were posed to a sample of 2,000 nationally representative UK adults about their thoughts on pensions. The results were broken down by age, gender, region and whether respondents had a pension.
Image Source: Getty Images
Connor is a writer and spokesperson for NerdWallet. Previously at Spreadex, his market commentary has been quoted in the likes of the BBC, The Guardian, Evening Standard, Reuters and The Independent. Read more