What are the risks of owning crypto?
To help you stay safe and protect your portfolio, we'll cover some of the common risks cryptocurrency holders are exposed to.
Cryptocurrencies as a whole are a young and emerging market—with many projects still in the stage of explosive price discovery. This in turn results in an unusually high price volatility that you wouldn't expect to see with other asset types.
There are a few other factors contributing to such dynamic movements—one of which being a vibrant, global crypto community that never sleeps. Unlike traditional stock markets, crypto is 24/7. Around the world, people are constantly searching the internet and social media for news that can give them an edge, and acting on it to produce massive hypes that often end as quickly as they start.
Another factor contributing to price volatility is a high degree of automation in the crypto market. There are many programs running nonstop, surveying the network for recognizable patterns. When these occur, it can create a cascade effect as many of the algorithms use similar criteria to predict future price movements.
Cryptocurrencies are a very young technology and market, so government bodies around the world are examining how to revise their tax laws and guidance to address different crypto activities. This means the legal landscape can change quickly and there can be uncertainty as to how new or existing tax laws apply to various crypto activities. It is the individual’s job alone to make sure that they pay any tax obligations from buying or selling cryptocurrencies.
It is crucially important to become familiar with the exact rules and tax guidelines for the jurisdiction you live in, and to stay aware of any upcoming changes to these as they are refined over time.
Custody of keys
Your private keys function as a verification mechanism embedded in your crypto wallet, allowing you to sign and send transactions from your wallet balance. Some wallet providers allow users to retain full custody of their keys—just providing a means to generate a new wallet and interact with it. Other wallet providers will manage the private keys on behalf of users, providing access through a secure login portal. Finding the right wallet for you can be tricky, with both custodial and non-custodial wallets each having its own tradeoffs in terms of security and recoverability.
Whoever holds a private key for a given wallet is able to sign transactions as if they were that wallet’s owner, so these should be kept extremely safe. Typically, software crypto wallet providers will prompt you to store a backup of your keys in a safe place, in case you ever lose access to your wallet. It probably goes without saying, but your private keys should not be shared with anyone or exposed publicly in any way.
Hardware cryptocurrency wallets like those offered by Ledger and Trezor are popular options with cryptocurrency holders today, allowing users to store their private keys on a device that remains offline and is less exposed to potential attackers.
Remember, it is no one else's responsibility but your own to keep your private keys safe. Make sure you choose a secure wallet and an appropriate backup method, and avoid storing any private key backups on an internet-connected device. Many wallet providers recommend storing backups in a safe place like a USB flash drive or as a paper copy.
Technical complexity and making mistakes
When sending cryptocurrencies, you need to input a receiving address. These come in the form of a long string made up of a mix of numbers and letters.
It is not uncommon—even for experienced users—to make a mistake while typing or even copying and pasting a receiving address. As transactions on the blockchain are irreversible, if you send your funds to the wrong address, there is no way to get them back.
Double— or even triple— checking the address before sending each transfer is a simple practice that can often save you a lot of stress later on. While sending big sums of money, it can also be helpful to split them into multiple transactions—the higher fees are compensated with higher security—so that even if something goes wrong with one of the transactions, not all funds will be lost.
Scammers and hackers
It is always a good idea to practice good digital hygiene when browsing the internet and interacting with online services. Setting strong, unique passwords and enabling two-factor authentication where possible is especially important for cryptocurrencies. Adept hackers can also exploit vulnerabilities in software to steal your data or take control of your device, so it is crucially important to keep your software and operating system up to date.
Cryptocurrency holders and users are also often targeted by scammers and tricksters. It is especially important to be wary of fake websites and phishing emails that pretend to be from reputable sources—no reputable crypto asset issuer or service provider will ask for your private keys or passwords.
Smart contract risk
Smart contract platforms like Ethereum allow developers to create apps that run on the blockchain without any oversight from a central party. This means that anyone can publish a smart contract.
The programming language used—Solidity—allows for the same logic as any other framework, so developers can literally build anything they like. When interacting with smart contracts, keep in mind that because blockchain technology involves a lot of complex concepts, there are many opportunities for developers to make mistakes, or for bad actors to include deceptive or malicious code that aims to steal your funds.
For the technically minded, it is possible to browse through a blockchain explorer like etherscan to read through the source code of smart contracts to see exactly what is going on.
Centralization and governance risk
While blockchains and cryptocurrencies are often decentralized, the business entities issuing them may not be. This means that in the case of some cryptocurrency projects, we are still relying on a trusted entity to act in the best interests of the project. This is true of popular projects like Tether (USDT) and Binance coin (BNB), where governance rights and control of the project are held by a core business entity and not given over to token holders.
Typically, incentives align for developers to make their project as successful as possible. Sometimes, however, these interests can diverge, or malicious team members may decide to attack the network from within for their own gain.
Because cryptocurrency projects often rely on contributions from many teams—from marketing to community support to development and R&D—there are a lot of opportunities for mismanagement. It is possible, for example, that a project may not meet its development milestones, delivery dates, or the expectations of the community in general, which could negatively affect the value of the product.
Getting involved with the cryptocurrency markets can expose you to new types of risks, but many believe that cryptocurrency may bring advantages over traditional financial infrastructure. In the coming years, many expect users and businesses around the world to continue to develop and adopt blockchain technologies, which could help to level out the uncertainty and bring about a more established, calm crypto market. For now, the best thing you can do is to educate yourself, practice good digital hygiene, and manage your risk.
Following security best practices while staying on top of the latest news and managing a crypto portfolio can be tricky. To find more resources you can dive into, check out our guide to the best crypto resources on the internet.