7 Risks of Cryptocurrency Investing and How to Handle Them

7 Risks of Cryptocurrency Investing and How to Handle Them

While I love cryptocurrencies and believe they are our economic future, in today’s educational piece, I’d like to cover the seven most important risks of cryptocurrency investing. Getting educated about risk will put you right on top of your game. Knowing your risk tolerance, you can create a strategy that protects you and your wealth. The risk associated with cryptocurrencies come in from many different sources. Here are the seven most important risks of cryptocurrency investing. You can learn more about these risks in my book, Cryptocurrency Investing for Dummies.

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1- Crypto hype risk

While getting hyped up in the thought of buying your dream car is a good thing, the hype surrounding cryptocurrencies is not always as exciting. The main reason why there is a lot of hype with cryptos is that most people don’t know about what they’re investing in. So instead, they end up listening to the crowd. The crypto hype back in 2017 was one the many drivers of the fast-and-furious market surge. Once people started to figure out what they’ve invested in, the prices crashed.

How to Manage – Risks of Cryptocurrency Investing

Before falling for the market noise, arm yourself with knowledge on the specific cryptos you are considering to purchase. There are plenty of opportunities to make lots of money in the crypto market. You should be patient and acquire the right knowledge, instead of betting on the current hype. An investor who trades on the hype probably doesn’t even have an investment strategy — unless you call gambling a strategy! You can find different methods of risk management in Invest Diva’s PowerCourse by attending this webinar.

2- Security risk

Scams. Hacking. Theft. These have been a common theme in the cryptocurrency market since Bitcoin’s inception in 2009. And with each scandal, the cryptocurrencies’ value is compromised as well, although temporary. There are three main ways your cryptocurrency can be compromised. Therefore, it is very important that you follow the safety precautions in every step of your cryptocurrency investing strategy.

How to Manage – Risks of Cryptocurrency Investing

  1. The cryptocurrency itself: There are hundreds of cryptocurrencies already available for investments, with thousands of new ICOs (Initial Coin Offerings) on the way (see Chapter 11 for more on ICOs). When choosing the cryptocurrency to invest in, you must educate yourself on their protocol and make sure there aren’t any bugs (or rumors of bugs) that could compromise your investment. You can find out about the nature of the cryptocurrency’s protocol on their white paper on their website. But it is unlikely that they share their shortcomings there. That’s why reading reviews on savvy websites like Reddit and InvestDiva.com can often be your best bet.
  2. The exchange:Exchanges are where you trade the cryptocurrency tokens (see Chapter 4 of  Cryptocurrency Investing for Dummies for more information). You need to make sure that your trading host is trustworthy and credible. There has been countless numbers of security incidents and data breaches in the crypto community because of the exchanges.
  3. Your wallet: Once you have passed the first two layers of security check, it comes to the final round. This one is all in your own hands. While you won’t be physically carrying your crypto-coins, you can sure store them in a secure physical wallet. You will actually be storing the public and private keys in these wallets. Doing so, you can use these keys for making transactions with your altcoins. Additionally, you can take your wallet’s security level to a higher level by using a backup. We will explore wallet safety methods more in Chapter 5 of Cryptocurrency Investing for Dummies.

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3- Volatility risk

Volatility risk is essentially the risk in the unexpected market movements. While volatility could be a good thing, it can also catch you off-guard sometimes. Just like any other market, the cryptocurrency market can suddenly move in the opposite direction from what you expected. If you are not prepared for the market volatility, you can lose the money you invested in the market.

The volatility in the cryptocurrency market has been a result of many factors. For one, it’s a brand-new technology. It has been well documented that the inception of revolutionary technologies — such as the Internet — can create initial periods of volatility. It takes a lot of getting-used-to before the blockchain technology (see Chapter 6 of Cryptocurrency Investing for Dummies) and its underpinning cryptocurrencies become mainstream.

How to Manage – Risks of Cryptocurrency Investing

The best way to combat the cryptocurrency volatility risk is looking at the big picture. Volatility matters a lot if you have a short-term investing horizon (see Chapter 17), because it is a proxy for how much money you might make or lose over a short period. But if you have a long-term horizon (see Chapter 18), volatility can turn into an opportunity.

4- Liquidity risk

By definition, liquidity risk is the risk of not being able to sell (or liquidate) an investment quickly at a reasonable price. Cryptocurrencies can also see episodes of illiquidity. Heck, the liquidity problem was one of the other factors which led to the high volatility in Bitcoin and other altcoins described earlier in this chapter. When the liquidity is low, there is also a risk of price manipulation. One big player can easily move the market to their favor by placing a massive order.

On the bright side, as cryptocurrency investing becomes more available and acceptable, the market could become more liquid. The increase in the number of trusted crypto exchanges will provide an opportunity for more people to trade.

How to Manage – Risks of Cryptocurrency Investing

When choosing a cryptocurrency to trade, you must consider its liquidity by analyzing its acceptance, popularity, and the number of exchanges it’s been traded on. Lesser-known cryptocurrencies could have a lot of upside potential, but could put you in trouble because of lack of liquidity.

We will explore different types of cryptocurrencies and their characteristics in Part 2 of Cryptocurrency Investing for Dummies.

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5- Vanishing risk

No, I’m not talking about magically getting vanished in the ever-magical blockchain industry. Quite the contrary. There are many cryptocurrencies that could vanish before our very eyes. There are currently hundreds of different cryptocurrencies out there. More and more cryptocurrencies are being introduced every day. In ten years time, many of these altcoins may vanish while others flourish.

A familiar example of vanishing risk is the dot-com bubble. In the late 1990s, many people around the world dreamed up businesses on the popularity of the internet. Some, such as Amazon and eBay, succeeded in conquering the world. Many more crashed and burned. Following the path of history, out of all the booming cryptocurrencies popping left and right, many are destined to bust.

How to Manage – Risks of Cryptocurrency Investing

To eliminate the vanishing risk, you need to analyze the fundamentals of the cryptocurrencies you choose to invest in. Does their goal make sense to you? Are they solving a problem that will continue in the years to come? Who are their partners? While you can’t vanish the vanishing risk entirely (pun intended) you can eliminate your exposure to a sudden bust. Check out Part 2 of Cryptocurrency Investing for Dummies book for more on Fundamental analysis.

6-Regulation risk

One of the initial attractions of cryptocurrencies was their lack of regulation. In the good old days in the crypto-land, crypto enthusiasts didn’t have to worry about the governments chasing them down. All they had was a white paper and a promise. However, as the demand for cryptocurrencies grows, global regulators are scratching their heads on how to keep up — and to not lose their shirts to the new economic reality.

How to Manage this Risk

The cryptocurrency regulation risk could be divided into two components. The regulation event risk, and the regulation’s nature itself. While the future of cryptocurrency regulations seems to be bright at the moment, it could impact the markets in the future. As the market grows stronger though, these impacts could turn into isolated events. Join our Premium Investing Group to stay ahead of regulation risks.

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7- Tax risk

When cryptocurrency investing first got popular, hardly anyone was paying taxes on their gains. There was a lot of underreporting going on. However, as the market gets more regulated, the authorities could become stricter on taxation. As of 2018, the IRS views Bitcoin and other cryptocurrencies as property. That’s despite the fact that they have the word “currencies” in them. Therefore, transactions using altcoins are subject to capital gains tax.

How to Manage this Risk

different countries, different rules. Personally I have been hit hard by taxes when moving from one country to another, or when the Congress made changes to their tax laws. Fortunately though I have been able to cover the taxes elsewhere. Had I not have enough savings in my emergency fund, I would have had to file an extension and pay a penalty too. That’s why it is crucial that you do your due diligence on taxing before developing your investment strategy. Flip to Chapter 21 of my book, Cryptocurrency Investing for Dummies for more details on taxes in relation to cryptocurrencies.

Risk management is an essential part of successful investing. Further, a diversified portfolio could help you reach your financial goals faster and easier. Join our investing group to get the latest investing strategies, stop-loss, take-profit and other limit order ideas on cryptocurrencies, forex and stocks. Our comprehensive signals will help you create a unique strategy for you, according to your risk tolerance.

As the 4th point of the IDDA technique, you must calculate your risk tolerance before deciding on the investment strategy that is suitable for your portfolio.

Don’t forget to complete your risk management due-diligence before developing your investment strategy.

Invest responsibly,