Many people are touting cryptocurrency as the most important development in the realms of finance and technology in many years. As a result, people are trying to get involved at record rates, as the volume of trading on cryptocurrency coin exchanges is higher than ever. You might be under the assumption that buying cryptocurrency for use in your daily life or as an investment is a can’t-miss prospect.
There are certainly many great benefits to using cryptocurrency. But going into any kind of investment or purchase without a clear view of the risks involved is not the best idea. You should take a look with clear eyes at the downside of the situation and the potential for loss before even considering moving ahead into the cryptocurrency realm.
This is not to say you should avoid cryptocurrency completely. But you should be aware of all the ways that the decision to purchase these digital coins can backfire on you. Only then, having explored all of the different possibilities, should you proceed.
What Cryptocurrency Is and Why It Ruffles Some Feathers
Understanding the risks of cryptocurrency requires you to first take a look at what these coins are and how they are used in society. Cryptocurrency began in earnest with the creation of Bitcoin around 2009. Bitcoin, the first cryptocurrency, was an effort by some developers to figure out a way to make transactions without paying a third party to oversee them.
The developers utilized a technology known as the blockchain to make this happen. Basically, the blockchain allows transactions to be validated and verified through a cryptographic process over a network of computers. The computers solve a coding problem and then add a link to the blockchain, thereby creating a digital ledger that records every step of the process.
That might all sound like a lot of technological mumbo-jumbo, but it basically means that you can trust the process of Bitcoin being transferred from one person to another. There can’t be any charge-backs or fraud, and all personal information is withheld. Only the amount of coins that is involved in the transaction changes hands, and there is no need for a bank, a credit card company, or any financial institution for that matter to get involved.
The Rise of the Altcoins
Bitcoin was soon joined in the cryptocurrency market by many followers. These coins were named altcoins, short for alternative coins, and used the blockchain for their purposes as well. Many of these coins also tried to solve personal finance problems, while others took on different markets and sectors, in much the same way that different stocks represent companies from many different industries.
In the case of the legitimate cryptocurrency coins, their goals were to replace third parties that people relied on the get things done. For example, instead of using a lawyer, you could enable a smart contract powered by the blockchain. Want to gamble on a game? No need for a bookie; just find a blockchain-powered site to help you out.
The possibilities are endless. And so are the major corporations and long-held businesses that might be replaced by this technology. Needless to say, those institutions, most of which have major political clout, have fought hard to restrict the power of cryptocurrency and keep from becoming obsolete.
Political and Institutional Pressure
For the most part, governments and regulatory bodies took a calm view of cryptocurrencies for the first several years of their existence, because the coins were hardly used in society. Then Bitcoin broke through in a big way, with the coins multiplying in value many times over. Suddenly, these institutional forces had to make a reckoning with this powerful new force in society.
As a result, the pressure on the digital coins scared a lot of people away. Many of the investors who got involved after the initial rush found their capital falling quickly. Certain governments tried to shut it down, and detractors argued against it. That led to the current state of volatility among the coins.
The Volatility Factor
When you buy into cryptocurrency, you might be doing so because you want to use the coins to buy products of services or to back a certain initiative. The problem is that the coins aren’t stationary in value. Instead, they rise and fall, almost as if you had invested in the stock market and watched as the price of your assets constantly seesawed in value.
All assets have some measure of volatility, but cryptocurrency coins are about the most volatile asset you can possess. As a result, the people who buy the coins run the risk of seeing their value drop significantly at any moment. They can also rise, of course, but for people wanting to use it as a currency, that can be problematic.
For example, imagine a small business that accepts a payment in Bitcoin. On the day that they receive it, Bitcoin is worth, let’s say, $8,000 per coin. A day later, some bad news hits, and the coins drop to $6,000. Suddenly, that business is short $2,000, which can cause a real cash flow problem.
Why So Volatile?
Understanding the reasons that Bitcoin and other cryptocurrencies tend to rise and fall at will in terms of their prices can help you deal with it. Here are three key reasons:
Since cryptocurrencies are relatively new assets, they haven’t yet developed the stability of traditional assets like stocks or bonds. After some time, the volatility should die off somewhat. In the meantime, investors have to be ready for the rollercoaster ride.
2. News Cycle
Cryptocurrency seems to be more susceptible to bad news about it than other assets. Whenever people hear about a coin that is struggling or there is some institutional pressure placed on the market as a whole, they tend to panic-sell. Since the news cycle is so active and cryptocurrency is a hot-button issue, it causes a lot of ups and downs.
3. Herd Mentality
Many people who invest in cryptocurrency do so out of the so-called FOMO, or fear of missing out. They don’t actually understand what it is that they’re purchasing. As a result, they sell when they see others selling and buy when others are buying, leading to huge surges in either direction.
Investigating the Claims Against Cryptocurrency
As we have stated, there are many people who have major issues with cryptocurrency. Whenever you hear people coming out against the coins, they often do so with the same laundry list of complaints. Let’s address these one by one, as some are unfounded while some do have some legitimacy to them. We’ll also look at how to protect against the ones that are legitimate.
Claims of Fraud
Naysayers will compare cryptocurrency to a Ponzi scheme, which is when investors buy into an asset, and the creators of that asset never follow through on their promises. They use investors’ money to pay off others, but they mostly pocket a large portion of it. That means that the investors usually end up with nothing.
When a cryptocurrency initiative is begun, it is usually started with what is known as an Initial Coin Offering. The idea is that the people who buy the coins do so in the hopes that they will one day become valuable and that the initiative funded by the coin will be worthwhile. They do this without much in the way of assurance that any of this will happen.
The truth is that there are individuals who will scam people with the newest, shiniest object, which, at the moment, is cryptocurrency. This means that they will promise great results without delivering. Since cryptocurrency is relatively unregulated, the people who get scammed have little recourse after the fact.
But there are ways to figure out the legitimate coins from the scams. Check out the websites of those offering proprietary coins. Look for bad grammar, a white paper description of the coins that makes little sense, and guarantees of return on investment. These are all signs that you should steer clear and look for coins that are backed with excellent technology, proven leadership, and an idea that will make a difference in society.
The Cryptocurrency Bubble
This skews more to people who are looking at cryptocurrency as an investment property. Many investment experts believe that the cryptocurrency market is nothing more than a so-called bubble. A bubble occurs when people invest in an asset without knowing what it is because they see others buying into it. The tech bubble at the start of the millennium is a famous example.
The truth is that there are many people who are in the crypto space without having a clear understanding of it. But another characteristic of a bubble is when the asset in question has no real value behind it. That really isn’t the case with cryptocurrency, as the blockchain technology legitimately could revolutionize the way people interact with each other without relying on corporations taking their percentage at every step.
Concerns of Hacking
There have undoubtedly been many instances where people have lost cryptocurrency funds because those funds were stolen by people who had hacked into the account. This generally happens when people keep their cryptocurrency stored in coin exchanges. Coin exchanges are used to buy and sell different coins or exchange traditional currencies into crypto assets.
Many of these coin exchanges, however, do not have the necessary security to hold people’s coins. These so-called custodial services are what banks have been specializing in for many years, but they haven’t been mastered by certain coin exchanges. It’s for that reason that you shouldn’t park all of your cryptocurrency in an exchange, even a trusted one.
Your best bet to absolutely protect against theft by hackers is to store your crypto funds in an offline wallet. This kind of “cold storage” means that only you have access to the digital keys that will unlock these funds. If you must utilize a coin exchange, try to do so only to buy or sell coins.
It is interesting that all three of those previous claims against cryptocurrency can actually be leveled against traditional assets. Ponzi schemes have been perpetrated using regular currency, there have been stock bubbles, and banks have been robbed. But one threat against cryptocurrency that may outweigh all the others is the concerns about regulation.
The bottom line is that it is unlikely that cryptocurrency can continue to exist without coming to some kind of agreement with regulatory bodies. What form that will take is hard to say and could differ from country to country. There could be national cryptocurrencies someday, or, at the very least, financial bodies will have much more of a say in the way that the coins are traded.
Some would say, for investors and users alike, that regulation coming to cryptocurrency is a positive thing. It could lead to them being traded on exchanges or being included in pension funds. Perhaps it will even lead to widespread indoctrination of the technologies proposed by the leading altcoins into society.
But there are many cryptocurrency adherents who feel that a heavy regulatory hand on the coins will essentially rob them of their essence. After all, the coins were created as a way of escaping the clutches of governments, lawmakers, and financial bodies. If all of those entities get their hands on cryptocurrency, there might not be anything left of the initial spirit behind its creation.
As you can tell, there are many complex issues to be worked out with cryptocurrency. Many risks will be incurred by those who decide to either invest in the coins or use them in some way, or both. The future of cryptocurrency, as exciting as it may be, is still very much up in the air.