Amazing gains are possible, but so are devastating losses, and investors should understand the various risks of crypto. Here is a summary of crypto volatility risk, technical risk, regulatory uncertainty and other issues that may affect the value of your investment.
Price volatility
Cryptocurrency prices can fluctuate wildly from week to week, or even within a single day. On May 19, 2021, for example, the price of bitcoin fell by 30%, after the Chinese government cracked down on bitcoin mining and trading.
Crypto prices may rise and fall based on various factors such as changing public sentiment, world news, mainstream adoption, protocol development, future regulation, hacks, scams and more. Also, crypto is a new asset class, and the market is in the process of price recovery.
Technical risks
Cryptocurrencies' underlying blockchain technology is built with multiple security measures, including decentralization, cryptography and consensus mechanisms to ensure transactions are legitimate. However, no blockchain is immune to all threats.
Backing up your crypto wallet regularly and keeping it safe helps protect you from computer failures, device theft, and personal mistakes—like accidentally withdrawing your digital wallet. But it is very difficult to monitor threats such as software bugs, data disruptions and 51% attacks (where a group of crypto miners take control of more than half of the network's computing power).
Crypto investors and developers are also concerned about the development of quantum computing, the next generation of computer technology. Its potential computing power could allow bad actors to hack crypto wallets, execute transactions or rewrite parts of the blockchain to alter transaction records. If that were to happen, crypto values could plummet—even be wiped out. That day is probably several years away, but Ethereum and other crypto entities are already working on post-quantum cryptography.
Low liquidity
Liquidity refers to how easily and quickly you can exchange assets for cash. Cryptocurrencies—especially smaller, newer ones—tend to be less liquid than other currencies like stocks and bonds. That means that trading or making money with digital coins may not happen as quickly as you would like, even though crypto markets around the world operate almost around the clock.
As a result, you may experience “slippage”—the difference between the price you expect and the price you receive once the trade is executed. Slippage occurs when the bid/ask spread—the gap between what buyers are willing to pay and what sellers are willing to accept—changes while you wait for your trade to be filled, perhaps even several times. If the actual price is lower than expected, your purchasing power increases; this is called “positive smoothness.” If the actual price is higher than expected, your purchasing power decreases; this is called “negative slippage.”
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