How would you feel about an asset that has wildly volatile price swings, no regulation or protections, and a seemingly endless number of scams?
That's the impression that new traders get when they first check out the cryptocurrency markets. The risk levels look off the charts, but cryptocurrency trading doesn't have to be as risky as it appears at first glance.
If you take some time to educate yourself about the markets and various cryptocurrencies you can substantially reduce the risk in your cryptocurrency trades.
To get your education started and help you avoid some of the risks associated with trading cryptocurrencies here are the top risks you need to be aware of in the markets.
Market Risk #1: Asset Volatility
Here we are at the end of 2018 and the bear market that gripped cryptocurrencies throughout most of 2018 is well known. From January through November the MVIS CryptoCompare Index lost roughly 80% of its value. That makes the 2018 cryptocurrency bear market worse than the dot-com bust of 2000 when technology indices lost 78%.
Bitcoin peaked just above $20,000 in December 2017 and went on to drop below $6,000 by mid-November 2018. The rest of the market looks similar too, with most altcoins dropping substantially throughout 2018 and showing little movement at all during September and October.
But we can't only look at 2018. Bitcoin and cryptocurrency markets have seen similar crashes before.
- In 2011 the first Mt. Gox hack caused a 95% drop in bitcoin.
- In 2013 banking issues in Cyprus caused a 52% move lower.
- And 2014 had a second My Gox hack leading to a 63% bitcoin loss.
This makes 2018 the fourth loss of more than 50% in cryptocurrencies. Volatility is the bread and butter of these markets, and it's also why some traders have become bitcoin and altcoin millionaires in such a short period of time.
Volatility can cause massive losses but can also cause massive gains. Ultimately you have to be prepared for the risk in cryptocurrency markets and avoid investing more than you can stand to lose.
Market Risk #2: Regulatory Issues
With little progress made on the regulatory front in 2018, this could be one of the largest risks in cryptocurrency trading in 2019. That’s because we simply don’t know what regulations and laws could be enacted, having a major impact on our trades.
The cryptocurrency asset class is just so new that governments and financial regulators haven’t yet decided how to classify and deal with them. Tax status, trading rules and even the legality could change on a dime, creating potential risks for you just by holding cryptocurrency.
Market Risk #3: Longevity
Not many traders think of it, but the growing number of altcoins can present trading risks. There’s probably more, but right now Coinmarketcap.com lists 2082 altcoins. And it’s an impossible task to complete due diligence on all of them to know which ones might have the potential to remain for the long term.
So far there are very few real world examples of mainstream blockchain adoption. Prices of coins are being driven solely by speculation. And experts in blockchain technology agree that nearly all the projects currently in existence will die off in the coming years.
Even after the bear market of 2018 there are 14 coins with market capitalizations greater than $1 billion. And that means nothing for the longevity of any of them. It’s simply far too early in the game to have any confidence that any single cryptocurrency will last more than a few years at best.
Market Risk #4: No Consumer Protection
So far there are absolutely no consumer protections for cryptocurrencies. No FDIC to protect your holdings, and no Better Business Bureau to complain to when an exchange treats you poorly. Speaking of exchanges, they are hacked frequently, and the return of your funds is completely up to the largesse of the exchange. With that said, there’s nothing to stop exchanges from manipulating prices to take your funds either. And that brings us to the next risk…
Market Risk #5: Market Manipulation
It’s been alleged many times, but it’s never been proven. Even without proof it’s widely believed that cryptocurrency markets are rife with collusion, market manipulation and insider trading. Experts have even hypothesized that the massive rally at the conclusion of 2017 was primarily due to the efforts of a small group of people with huge cryptocurrency holdings working together.
It’s well known that there are so called “pump and dump” groups, and seeing an altcoin shoot up one day and crash the next is commonplace. It’s also common to see accumulation of coins ahead of positive news, and dark pools are used to keep exchanges unaware of trade volume.
The lack of regulation makes these activities impossible to prevent, yet they do add risk to the markets, especially for new traders unaware of the morally questionable tactics sometimes being used.
Market Risk #6: Market Exits
Even the most devout cryptocurrency enthusiasts may want to cash in their altcoins for fiat at some point. Surprisingly, this too can create risk. It’s improving but moving cryptocurrencies back into fiat can be a difficult proposition. Several factors contribute to this problem:
- Most exchanges require KYC and AML verification before allowing withdrawals. This process can take valuable time.
- Many exchanges that allow fiat withdrawals only support a handful of the largest coins.
- Most exchanges only allow USD withdrawals. There are some that support EUR, GBP and JPY withdrawals, but the choice is frustratingly limited.
- Exchanges may have tight limits on fiat withdrawals.
- Exchanges have been accused of withholding or freezing funds for vague reasons.
As I said it is getting better, but it wouldn’t be unusual to see a trade that went like this:
Monero -> Bitcoin -> USD -> GBP
Not only does this introduce added costs, it also adds uncertainty about the true value of your crypto holdings and your ability to use them when they’re needed.
Market Risk #7: Scams
We all know that scams are widespread in the cryptocurrency industry and newcomers are most susceptible to getting pulled in and ripped off.
One common type of scam is the fake ICO. An ICO is the equivalent of a stock market IPO. Unfortunately too many people fail to do research into ICOs they hear about. Scammers quickly learned this, and they were quick to jump in and offer fake ICOs or set up phishing sites that looked like a known ICO. Once they get their hands on the cash – poof! – they’re gone.
Another common scam is on the social media platform Twitter. Scammers set up accounts that look official and promise to pay out a certain amount of coins in the future for a small deposit today.
Finally there are the Ponzi schemes that are branded as blockchain projects. The most famous include Bitconnect, Plexcoin and OneCoin. Remember that even in cryptocurrencies if it sounds too good to be true it often is too good to be true.
Market Risk #8: Human Error
You simply can’t avoid human error in pretty much anything you do, but with cryptocurrencies mistakes are easier to make and the risks are very real. Those with no trading experience are going to find the exchange interfaces very confusing, and the chance of making a mistake there for newcomers is nearly guaranteed. Placing an incorrect order is the smallest risk too. You could send your coins to the wrong address, or even lock yourself out of your account or wallet entirely.
Risks are a part of any investing strategy. That’s why risk/reward ratios are so common around investments. When it comes to cryptocurrency trading, you’ll find both the risks and rewards at an extremely high level. If you don’t have the mental fortitude to watch an asset you own move by 10% or more in a single day, then cryptocurrency trading might not be for you. But if you can manage the risk that comes with cryptocurrency trading you could find it is a very rewarding activity.
Bitcoin Volatility.png from https://www.buybitcoinworldwide.com/volatility-index/