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The risks of cryptocurrency trading: what to look out for

Peter Terlato avatar
Peter Terlato
- 7 min read
The risks of cryptocurrency trading: what to look out for

Every investment involves a degree of risk. Buying, selling and trading cryptocurrency is no different. In fact, many financial experts and commentators will often argue that there is a heightened risk attached to crypto markets compared to more traditional investments, such as trading securities or foreign exchange (forex or FX) transactions.

It’s important to assess all potential risks when making any investment so that you can make the best decision for your personal financial circumstances and goals.

What are the risks of trading cryptocurrencies?

Most cryptocurrencies are unstable assets, prone to significant market movements and vulnerable to abrupt abolition. While there are some proven stayers, much of the industry is relatively fickle and exchanges have encountered extreme levels of volatility since inception.

It’s not uncommon to witness sudden and prolific price movements. Individual coin values can rise and drop dramatically over short periods, gaining or shedding hundreds or even thousands of dollars.

While most money markets are tough to predict, crypto is akin to the wild west. There are literally thousands of coins available to trade but the most well known is easily Bitcoin. It has the largest market capitalisation of any cryptocurrency, more than double that of its nearest competitor.

Stability concerns

While the industry is still in its infancy, Bitcoin has, so far, stood the test of time. It was the first digital asset to garner worldwide attention and continues to be the dominant token, often influencing trading values across the marketplace.

Many alternative cryptocurrency (altcoins) exchange rates are priced against Bitcoin, owing to its superior status and popularity as a store of value among traders. Additionally, many global crypto exchanges do not offer crypto-to-fiat conversions because of regulatory and compliance issues. Instead, they rely on Bitcoin as the primary market pair, encouraging traders to do the same.

Bitcoin’s overarching influence on cryptocurrency markets makes its value and performance a crucial consideration when investing in any cryptocurrency.

Since there is generally no central authority governing cryptocurrencies, there can be no guarantee of a minimum valuation. If a large group of traders, or a small group with large holdings, decide to “dump” their coins, the crypto’s valuation is likely to decrease significantly. Therefore, the decentralised nature of cryptocurrencies can be seen as both a blessing and a curse.

Functionality and adoption

Funds are either held in a hot wallet on digital exchanges - risking exposure to hackers, system crashes and other technical issues - or they can be stored on cold wallets in the form of an external hard drive, which may be lost, damaged or stolen.

Very few cryptocurrencies are accepted as a legitimate form of payment. A small number of online global merchants may allow you to make purchases with particular coins but it’s hardly possible to pop down to your local supermarket and buy groceries with Bitcoin. Taking out a home loan and offering cryptocurrency as a deposit won’t fly either.

The adoption of Bitcoin and other cryptocurrencies as valid currency may not ever come to fruition. Governments, financial institutions and other monetary authorities have already begun regulating digital assets, which, to some degree, defeats their original purpose.

However, there may be potential for stablecoins to become reliable methods of settlement. The proposition of these types of altcoins is to offer an equable market pair with fiat currencies, such as the US dollar, thus reducing or eliminating price volatility. Both Tether and USD Coin are supported by the Coinbase Commerce platform.

As with any burgeoning industry, there are likely to be unforeseen changes and developments that could potentially negatively affect your investment.

The uncertainty of altcoins and the potential for failure

The most inherent risk associated with any cryptocurrency investment is collapse.

Altcoins have a remarkably high failure rate. In 2018, He Baohong, a director at the China Academy of Information and Communications Technology (CAICT) estimated that 92% of all blockchain projects fail.

Baohong noted that of the more than 80,000 blockchain businesses that had been launched since the technology’s breakout role as Bitcoin’s digital ledger in 2008, only 6,400 (8%) were still actively maintained. He estimated that the average lifespan of a blockchain project was just 1.22 years.

While there have been a slew of successful altcoins launched since 2018, these statistics are unlikely to have fluctuated greatly. This struggle for survival and lack of longevity speaks to the infancy of the industry and the inexperience of investors.

Crypto collapses can also be a result of a hard fork. These instances typically occur when a cryptocurrency’s users want to create a new digital currency on an independent blockchain, often out of dissatisfaction or differing views for the future of the enterprise.

If you invest in an altcoin that fails, you’re likely to lose all your vested interests. There are a finite number of insurers offering limited protections, such as theft cover. Comprehensive policies are difficult to come by and if you’re only staking a small amount of capital the costs may not be justifiable.

Scams

Over one million Australians aged 18+ hold cryptocurrency - at an average value of just over $20,000, according to the latest research by Roy Morgan. That’s only one in 20 people. Those uninvolved may be dissuaded by market volatility, scams and the possibility of losing their money.

Scams are rife throughout the unregulated digital corridors of the internet. There is next-to-no recourse for those who fall victim to cryptocurrency scams. These deceptions are often complex, fast and anonymous with fraudsters commonly preying on unseasoned, first-time investors.

Australians lost more than $205 million to scams during the first four months of this year, according to the Australian Competition and Consumer Commission’s (ACCC) Scamwatch. More than half of these losses - $113 million - were attributed to investment scams involving cryptocurrency. Cryptocurrency was also reported as the most common payment method for investment scams.

“Australians should be very wary of anyone asking them to invest in or transfer money using cryptocurrency, especially if it’s someone you have only met online. Many consumers are unfamiliar with the complexities of cryptocurrency and this can make them more vulnerable to scams,” ACCC Deputy Chair Delia Rickard said.

What about NFT’s and cryptoart?

While you’ve likely heard of Non-Fungible Tokens (NFTs), their purpose may elude you. NFTs are recorded and stored on a digital ledger aka the blockchain. NFTs authenticate cryptoart, providing an immutable digital footprint of ownership. To better comprehend what this means, think of NFTs as unique identifiers tethered to individual works of art. When cryptoart is bought, sold or gifted, an NFT transaction is validated across the entire blockchain network.

How can you manage your risk?

There are a number of strategies you might want to consider as a means of gauging the level of risk you’ll need to accept in order to trade cryptocurrencies. These include: 

  • Conducting extensive research on the company or companies you intend to invest in
  • Decide on an affordable and acceptable amount to invest
  • Account for all the costs and fees associated with individual trades
  • Consider when you expect a return on your investment (ROI)
  • Factor in timing (period/length of investment) and the accessibility of funds

Given its esoteric reputation, you might assume that cryptocurrency is not a taxable asset in Australia. Think again. The Australian Taxation Office (ATO) has your crypto earnings in its crosshairs, so don’t skip on your declarations.

Should I borrow to invest?

Borrowing to invest can offer access to funds and increase purchasing power. There may also be tax benefits, such as deductions on income, if you’re on a high marginal tax rate. However, this can be a risky financial strategy.

Before borrowing to invest, it might be sensible to ask yourself these questions:

  • How much are you willing to risk?
  • How safe is the investment platform?
  • Have you built a diverse portfolio?
  • When do you expect to see a return on investment (ROI)?

You’ll also want to be confident that you can comfortably service the costs of borrowing, including repayment of the principal and any interest accrued.

Note: Every investment is a risk. Past performance is not a reliable indicator of future performance. Before investing in crypto or other assets, consider seeking financial advice to determine what's best for your financial situation.

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Cryptocurrencies available: 57

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Cryptocurrencies available: 245

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CoinSpot

Cryptocurrencies available: 263

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Cryptocurrencies available: 280+

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Product database updated 19 Apr, 2024