Investing in cryptocurrencies without fully understanding the risks involved is an invitation to unpleasant surprises and potential loss of money.
In this post, I will share with you everything that could go wrong with your crypto investment and what you can do about it to secure your money and mental health.
5 major risks of investing in crypto
Below are the major risks of investing in crypto that you must take note of before you dip your feet in the water.
Let’s discuss each of them below.
1. Volatility risk
The first and inescapable risk of investing in crypto is volatility.
Volatility is a measure of how much the price of a cryptocurrency changes over a given period of time. It reflects the degree of uncertainty and risk in the crypto market.
Cryptocurrencies are the most volatile asset class in the world right now. They’re subject to extreme and unexpected price fluctuations due to low liquidity, market manipulations, etc.
In crypto, it’s normal to see a token’s price move up or down by -90% or +500% in a few hours or days. As such the $1000 you invested this morning could be worth $5,000 or $100 (more or less) in under 1 week.
If you know you can’t handle such a high level of risk, that’s fine. Just avoid crypto. There are thousands of other things you can invest in and still make money.
But if you want to test the crypto waters and see where it takes you, you can start with a negligible amount and increase your exposure as you get more comfortable.
The crypto market is this volatile because it’s relatively new, liquidity is still low, and everything runs on speculation as investors bet on prices going up or down.
How to manage the volatility risk in crypto
There’s a popular saying in crypto, “When in doubt, zoom out.”
It means you should look at the bigger picture and have a long-term focus instead of worrying over short-term price movements. Because in the long run, prices mostly go up, if you’ve invested in the right such as BTC, ETH, BNB, etc.
So your best weapon against volatility is lots of patience and investing only in highly liquid blue-chip coins as they tend to be less volatile.
However, nobody knows how long you have to wait to be in profit. It could be a few weeks, months, or even multiple years.
But if you have invested in great projects with solid fundamentals, the wait will be worth it.
These blue-chip coins are still extremely volatile compared to traditional assets, but they’re more stable than the lesser-known, low-market-cap tokens.
2. Risk of scam
According to a Chainalysis report, $20 billion worth of cryptocurrencies was lost to scams in 2022 alone, up from $18 billion in 2021. And these are only the known ones.
And in the first half of 2023, over $1 billion has already been lost to scams if you exclude. Though the amount being lost to scams seems to be on the low in 2023, the rate of scams in crypto is still very high.
How are scammers stealing so much money?
Generally, crypto scammers steal mostly through hacks and exploits, exit scams/rug pulls, pumps and dumps, etc.
On an individual level, they prey on your fear, greed, and ignorance to take your money from you.
For example, some projects will promise you huge and unreasonable returns or get-rich-quick opportunities that appeal to your greed.
If you’re the greedy type, your focus would be mostly on the promised reward, ignoring the glaring scam that it is.
Secondly, some scammers use fear to pressure you into clicking their phishing links. If you click through and do what they ask on the site, your wallet will be drained.
For example, they will send you a message that “threatens” to close your account unless you click their phishing link and do some bullshit verification thing.
If you follow their instruction, whatever coin or token you have in your wallet will be gone.
Thirdly, others prey on your ignorance of crypto to mislead you into parting away with your money on scam projects.
How to manage the risk of scams in crypto
First, don’t make decisions based on your greed or fear. It’s hard but you must keep them in check always.
Nobody is here with a mission to make you rich overnight. Be wary of any project that promises to make you rich by doing nothing.
Secondly, don’t click unfamiliar links. Visit all websites by typing their address directly in the address bar or bookmark them for quick access.
Better still, right-click or hover your mouse over every hyperlink to view the link behind it and confirm that it’s the correct one before clicking through.
And lastly, try and educate yourself as much as possible and be aware that most celebrities or influencers make money from giving you bad advice.
They’re paid to recommend shitcoins to their followers who eventually end up as exit liquidity for them and the scammers.
So, before you invest based on the advice of some crypto “experts” or influencers on YouTube or wherever, take your time to do your own research and form your own opinion.
Because, at the end of the day, the outcome of your investment decision is your responsibility.
Finally, join a community of like-minded crypto investors where you can freely share or learn from each other and stay up to date on what’s happening in the market.
That’s what the CryptoSorted Discord is all about. There, we talk about crypto all day, sharing knowledge, experiences, and strategies to help each other.
Of course, there’re hundreds of other communities on Telegram, Reddit, Discord, and Twitter you can join to stay current in the market.
3. Regulatory or legal risks
Crypto is currently unregulated in most countries or at best, under-regulated in some.
Countries and governments all over the world are still learning and trying to understand how best to regulate crypto.
That’s some good news as regulation will bring greater clarity and open more doors for institutional money and the masses to embrace crypto.
But, these laws are being formulated while your money is already invested in the market. Talk about playing the game before the rules are declared.
The regulatory frameworks being created could end up favouring your investment or killing it. You have no idea which it’s going to be, and that’s a big risk we’re all taking.
The most important of these regulations to take seriously include tax laws, KYC requirements, and what constitutes or does not constitute a security.
How to manage regulatory risk
Follow the discussions and development of legal frameworks for crypto in your country, especially in developed nations.
And then begin to adjust your portfolio accordingly to stay on the safe side.
Don’t worry if your country hasn’t started developing any regulatory framework for crypto yet. Most countries are copycats of laws from developed nations.
By following the developments in other countries, you’ll be far ahead of the game and well-prepared when your own country decides it’s time to regulate crypto.
And always remember that “ignorance of the law is not an excuse”. It’s your responsibility to keep yourself informed of what’s legally required of you and your crypto investment.
4. Risk of hacks and exploits
DeFi protocols, exchanges or other centralised platforms where you deposit your crypto assets can be hacked or exploited and your coins stolen.
This risk can affect you in 3 major ways, depending on your involvement with the projects or coins involved.
- The funds could be totally or partially stolen from the hacked or exploited platform and smart contract. And the platform may not be able to reimburse you fully (if at all).
- The price of the native token of the hacked platform could drop significantly and if you’re invested in it, you will lose money.
- The coins stolen would usually be dumbed by the hackers and this would cause their price to crash and they may never recover. If you’re invested in any of these stolen coins, you’ll lose money as a result of the dump. Except you’re able to sell fast before the scammers dump it all.
How to manage the risk of hacks and exploits
You can’t stop a platform from being hacked or exploited, but you can reduce your exposure to such risks by:
- Never leave your money on a centralized platform unless you’re actively using it to trade or staking etc. And even then, only use the most reliable platforms, preferably with some form of insurance and a good security system.
- Avoid using unaudited smart contracts as much as possible or use a separate wallet whenever you have to connect to an unaudited contract. An audit does not necessarily mean that a smart contract cannot be hacked, but it eliminates a lot of bugs that could be exploited. Making it a lot safer than an unaudited smart contract.
- Never keep all your funds in a single wallet or platform, so that if one happens to get hacked, you will still have funds in others. The more wallets you maintain, the less likely you are to be wiped out with a single hack.
- Do not connect your wallet to phishing websites. They’re designed to steal any asset on your wallet or account. Always double-check that you’re on the correct website before doing anything.
5. Risk of business failure
Investing in crypto is similar to buying the shares of a traditional company on a stock exchange.
In both cases, you’re betting on the success of the business or company behind it. But not every business would survive and thrive in the long run.
In fact, it’s a popular belief that about 90% of all existing cryptocurrencies will fail or die within 1 to 5 years.
And it could be one or more of the coins you have in your portfolio right now or the next ones you’re going to buy.
How to manage the risk of crypto project failure
It’s hard to tell exactly which crypto project will survive or die within any timeframe, but you can make fairly accurate educated guesses by learning to do fundamental analysis to find the ones with higher chances of success.
Secondly, you have to constantly monitor and evaluate the progress of the projects you’re invested in and rebalance your portfolio accordingly.
Remember, portfolio management is one of the six (6) stages of cryptocurrency investment and it’s a never-ending process.
Investing in crypto is one of the boldest money moves you’ll ever make. The market is not only extremely volatile, but it’s also highly unregulated and heavily manipulated.
And there are just too many ways to lose your money with no hope of recovery. From scams to ignorant and expensive mistakes, hacks, business failures, regulatory risks, etc.
You have to be on top of your game at all times to survive in this jungle. That’s why we have shared with you the major risks of investing in crypto and how you can manage them effectively.
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