Cryptocurrencies are considered to be dangerous by many people in the world, some see it as a fad while others see it as an invention that would revolutionize the financial sector.
While many consider cryptocurrencies to be dangerous and risky, their fears must have sprung from several reasons which would be discussed in the article.
Every invention comes with its own risks and cryptocurrencies aren’t left out. There are risks to trading cryptocurrencies, and these risks should be clearly understood by potential investors and already existing investors.
A majority of the risks involved in trading cryptocurrencies are related to the volatility of the entities. It might be of interest to you to note that several people in the world, central banks, states and their financial regulators are still trying to get a hang of this new digital currency.
While some countries are beginning to make some cryptocurrencies legal tender, some are putting regulatory bans on cryptocurrencies and this is as a result of their fear of the risks associated with crypto trading.
In 2021, the president of El Salvador, Nayib Bukele signed the bill to make Bitcoin a legal tender, making El Salvador the first country to make Bitcoin a legal tender.
Amid the wide acceptance of crypto trading, many countries and regulatory bodies are laying bans on crypto trading. China banned crypto mining which pushed crypto miners to countries like Kazakhstan, Iran amongst others.
Just recently, Biden signed an executive bill on cryptocurrencies. A bill that was delayed due to the Ukraine-Russia war.
The major contributors to the risks of cryptocurrencies are their volatility, the fact that they’re unregulated, their susceptibility to hacking and lastly, the fact that cryptocurrencies usually experience discontinuations or forks.
This article breaks down the risks associated with crypto trading and why it is considered by most people to be dangerous.
- Cryptocurrency trading still remains a fad to a wide number of people.
- As a smart crypto investor, it is wise to get acquainted with the risk factors involved in crypto trading as well as regulations from regulatory bodies.
- Cryptocurrencies are highly susceptible to rug pulls
- Hack attacks are becoming commonplace in cryptocurrency trading.
Risk factors involved in trading cryptocurrencies
Here’s a quick look at some of the risk factors to consider when trading cryptocurrencies.
1. Cryptocurrencies are not regulated and are decentralized
One of the things that differentiate cryptocurrencies from fiat currency is that they are decentralized, digital and unregulated. The fact that it is unregulated makes it possible for large amounts of money to be transferred in cryptocurrencies.
It’s important to understand the role of fiat currencies in a country’s economy in order to better understand why governments are wary of cryptocurrency.
The term “fiat” refers to government-issued currencies. Fiat money is backed by a government’s full faith and credit and it is centralized, as opposed to decentralized cryptocurrencies which are unregulated. Invariably, this means the government’s promise to repay a currency borrower in the event of a default.
Capital controls are frequently implemented by governments to prevent currency outflows that could debase the currency’s value. For some, this is yet another form of government control over economic and fiscal policy. The stateless nature of bitcoin comes in handy in such situations for circumventing capital controls and exporting wealth.
The non-regulation of cryptocurrency is one factor that has greatly influenced the Russia-Ukraine war. Donations have been made to Ukraine in cryptocurrencies and they’ve also used cryptocurrency to purchase war artillery. Russia has seemingly evaded sanctions imposed on it as they still have access to cryptocurrency.
Moreso, the fact that cryptocurrencies are not regulated makes it possible for people to use them for illegal transactions and even money laundering.
The IMF warned in October 2021 that the global boom of unregulated cryptocurrencies portends high risks. The IMF reiterated that a four-fold increase in the supply of stable coins aims to peg their values against the US dollar to $120B by the end of 2021.
Several regulatory bodies, including the US SEC, the IMF, as well as central banks of some countries have flagged up campaigns aimed at regulating cryptocurrencies. Since it is asserted by these bodies that crypto transactions propel money laundering as well as other risks involved, regulatory bodies have moved to place several sanctions on cryptocurrency trading.
On the 15th of November 2021, Biden’s administration signed the Infrastructure Bill. A bill that expresses two major items crypto investors should know.
Brokers, or cryptocurrency exchanges, will be required to issue a 1099-B under the new law. What this simply means is that crypto exchanges will now be required to report crypto transactions to the IRS directly. “For many crypto investors, the bill will signal the end of hiding many gains,” says Grant Maddox, an independent CFP based in South Carolina.
Many crypto investors will face tax reporting challenges as a result, according to Grant Maddox. This is because the exchanges reporting on trading activity will have a limited view into what these investors paid for crypto in the first place, the information reported to the IRS on the 1099 form for investors who use their own crypto wallet will be prone to inaccuracy.
2. Cryptocurrencies are prone to hacking and errors
Humans have still not been able to totally prevent hack attacks and errors in technology. Cryptocurrency exchanges have had their fair share of hack attacks since their inception. Since cryptocurrency exchanges are digital, they are vulnerable to hackers, system failures, and malware attacks.
Blockchain-based systems, like many other financial systems, are vulnerable to a variety of hacks, frauds, and scams. These attacks take advantage of the Internet’s speed and anonymity. When it comes to obtaining remedies for these Internet-based crimes, there is a slew of legal hurdles to overcome.
This holds true for blockchain hacks, scams, and frauds just as much as it does for a variety of other Internet crimes and wrongdoings.
How are cryptocurrencies hacked?
Cryptocurrencies are stored in wallets and traded on exchanges such as Binance, Coinbase, Trustwallet, and Pancake Swap.
Two-factor identification is commonly used as a security measure in cryptocurrency transactions. Of course, when a transaction’s security is linked to an email address or a phone number, anyone with access to those components can authenticate transactions. Hackers may be able to infiltrate your cryptocurrency transactions regardless of whether they have access to some of your non-cryptocurrency personal information.
Since the inception of cryptocurrencies, there have been countless well-publicized frauds, scams, and hacks that have afflicted individual investors and even major cryptocurrency exchanges. Part of the problem is that the technology and the space are both new.
To best protect cryptocurrency holdings, all cryptocurrency investors are advised to take the necessary precautions.
3. Crypto rug pulls
Rug pull is one of the most common Decentralized Finance (DeFi) crimes, and it affects both individuals and businesses. This guide will teach you everything you need to know about rug pulls, including how to avoid them.
When a malicious cryptocurrency developer abandons a project and flees with investor funds, this is known as a rug pull. Criminals create a token, list it on a decentralized exchange (DEX), and then pair it with a large cryptocurrency like Ethereum.
By removing money from the liquidity pool, the creators drive the coin’s price to zero. In order to gain investor confidence, their creators may even create a brief buzz on Telegram, Twitter, and other social media platforms by flooding their pool with liquidity.
Unlike centralized cryptocurrency exchanges, DEXs allow users to publish tokens for free and without the need for auditing. Token creation is also simple and free on open source blockchains like Ethereum. These two factors are used by malicious actors.
Rug pulls are most commonly seen when fraudulent developers create new cryptocurrency tokens, then manipulate the price of those tokens to extract as much value as possible before abandoning them when their price falls to zero. Rugpulls are similar to exit scams in the sense that they are difficult to detect.
Rug pulls are a type of exit scam that, in some cases, can also be used as decentralized finance (DeFi) hack.
4. Social engineering and misinformation risks
Cryptocurrencies are closely linked to social engineering and misinformation. As in the analog economy, naive cryptocurrency investors are vulnerable to cyber extortion, market manipulation, fraud, and other investor dangers.
The Securities and Exchange Commission (SEC) of the United States has gone so far as to create a phoney initial coin offering (ICO) website to warn potential crypto investors about “shiny object” risks.
Regardless, many people have been duped by what they read on the internet and have been victims of fraudulent crypto activity.
Indeed, a rising area of securities interest is increasing regulatory clarification on what defines a truly decentralized asset, such as bitcoin or ethereum, which is outside the control of any single party, versus company-issued coins or tokens.
5. Environmental concerns of cryptocurrencies
The most crucial issue to consider before investing in cryptocurrencies is their influence on the environment.
According to the Cambridge Bitcoin Electricity Consumption Index, Bitcoin, the most extensively mined cryptocurrency network, consumes 122.87 Terawatt-hours of electricity annually, which is more than Argentina, the Netherlands, or the United Arab Emirates combined.
As reported by Digiconomist, a cryptocurrency analytics site, mining a single Bitcoin block can take up to 2,000 kilowatt-hours of electricity, which is roughly equivalent to the amount of power used by the average American family for 72.2 days.
Furthermore, according to Digiconomist, the Ethereum network consumed 99.6 Terawatt-hours of electricity every year, which is more than the Philippines or Belgium require.
A single Ethereum block consumed 220 kilowatt-hours of electricity, which is equivalent to the amount of electricity consumed by an ordinary American family in 7.44 days. 6 However, Ethereum has subsequently switched to Proof-of-State (PoS), which does not require the same amount of energy-intensive mining as Proof-of-Work (PoW).
Bitcoin mining, according to Digiconomist, emits around 96 million tons of carbon dioxide every year, which is comparable to the emissions produced by several smaller countries. On the other hand, Ethereum mining emits more than 47 million tons of carbon dioxide.
According to researchers at the University of Cambridge in 2021, 35% of Bitcoin mining takes place in the United States. The majority of electricity in the United States is generated by burning fossil fuels.
Kazakhstan, another country that relies heavily on fossil fuels for its energy, follows the United States in accounting for 18% of global Bitcoin mining. As a result, the majority of Bitcoin mining takes place in two countries that are largely reliant on fossil fuels. Many cryptocurrencies’ mining processes are extremely energy-intensive
Although the environmental impact may not directly affect you, at least for the time being, it is an inescapable consideration when deciding whether or not to invest in cryptocurrencies.
Since their introduction to the world in the aftermath of the financial crisis, cryptocurrencies have become a flashpoint for debate. Governments have grown apprehensive of cryptocurrencies and have alternated between denouncing them and studying their usage for their own purposes.
Governments have grown apprehensive of cryptocurrencies and have alternated between denouncing them and studying their usage for their own purposes.
Cryptocurrencies will continue to elicit distrust and criticism from established authorities until their ecosystem grows and a strong use case for it is discovered.
With so many possible impediments to mainstream adoption, it’s understandable that seasoned investors like Warren Buffet would choose to play it safe with this technology.
Nonetheless, we know that cryptocurrencies will be around for a long time. They provide far too many of the benefits that customers seek in a currency today, including decentralization, transparency, and flexibility. This notion is reinforced even further when the discussion is expanded to include everything that cryptocurrencies can do across a variety of businesses.