Risks associated with cryptocurrency against investors are well documented. However, other cryptocurrency risks have not yet been investigated. Generally, we can further propose a grouping of these risks into social risks, legal risks, economic risks, technological risks, and security risks.
The following are significant risks, particularly security risks, facing investors involved in the cryptocurrency market:
- Volatility
- Cybertheft and Hacks
- Decentralization
- Risks Associated with Peer-to-Peer Transactions
- Loss or Destruction of Private Keys
- Unregulated Trading Market
- Regional Regulation
- Currency Conversion Risks
- Privacy Risks
Risks in the Cryptocurrency Domain
When users interact with blockchain-based technologies, they are directly or indirectly exposed to a significant number of risks. The underlying security concerns in Bitcoin and possible scammers or hackers that might compromise the distributed ledger. However, most of these scammers or hackers only indirectly affect the investors involved in the cryptocurrency investment.
Concerns Regarding Usable Security and Privacy
In addition to cryptocurrency assets being lost due to technological vulnerabilities, cryptocurrency investors induced errors are very common. Bitcoin is theft-resistant by design, and assets can be compromised by private key leakages.
Conducted a cognitive walkthrough for various Bitcoin key management systems. The findings suggest that the metaphors being used can often be unclear for cryptocurrency investors, leading them to make dangerous errors.
Further investigating cryptocurrency investors’ mental models of risk should make it possible to address inconsistencies that could lead to dangerous errors. Such errors pose a risk and can lead to the loss of assets. It is, therefore, of interest to understand the behavior of cryptocurrency investors when it comes to the protection of their crypto-assets. By expanding the study beyond Bitcoin and investigating security behaviors regarding crypto-assets in general, it should be possible to understand what factors influence cryptocurrency investors in their decision-making.
Risks Associated With Cryptocurrency Volatility
When examining the 57 cryptocurrencies with the available data between 2015 to 2019. Only few cryptocurrencies are slightly predictable if the algorithms with the highest accuracies are chosen.
Cryptocurrencies have captured the attention of many investors across the spectrum, from retail to institutional. When we extend our understanding of the behavior of cryptocurrencies. We identify several interesting findings. First, we find that Principal Component Analysis PCA reveals that the return generating process is much more complex than that for stock returns. Generally speaking, the financial community agrees that the market is the first dominant Principal Component Analysis in stock returns.
Also, we document a strong beta-in-the-tails hidden risk associated with Bitcoin daily returns. Similar to hedge funds, cryptocurrencies may have some unstable tail behaviors.
Our analysis of machine learning algorithms applied to the data from cryptocurrencies hints that predictability may be difficult, and there are many heterogeneous effects here. Therefore, it is risky for investors to try to predict the price of the cryptocurrency.
However, some information sets perform better with some families of algorithms, and larger cryptocurrencies with lower volatility maybe more predictable than smaller cryptocurrencies with higher volatility. Given the many moving parts across the cryptocurrency industry, some care should be taken.
Cybertheft and Hacks
The reason that cryptocurrencies are held in digital walletsand traded through digital currency exchanges, leaves them vulnerable to cyber-attacks. Because cryptocurrencies are particularly online dependent and anonymity, leaving them also to cyberattacks. To gain access to cryptocurrency wallets and trading platforms, criminals use a variety of phishing attacks.
Fortunately, individuals and companies investing in cryptocurrency are adhered to strict internet security protocols to safeguard their assets. Most cryptocurrency investors are becoming more aware of the latest threats, which help them to understand how to protect their crypto assets and crypto-wallets.
The risk is entirely on the investors, with no formal protection in place if they take the wrong gamble. There has been a significant rise in crypto scams, with many wallets held on the blockchain being fed into scam companies and the wallets emptied and stolen. For instance, in one scam, scammers posing as developers raise the funds to develop a project. The project is then promptly abandoned, and the scammers escape with the investors’ funds.
For instance, in 2021, “rug pulls” accounted for over 2.8 billion USD stolen, or 37 percent of all cryptocurrency scam revenue, compared to one percent in 2020.
What are the Decentralization Risks
Cryptocurrency’s, decentralized nature makes it difficult to pinpoint the correct entity with which to file a transaction dispute. As a result, most cryptocurrency investors are advised to trade through reputable digital currency exchanges.
Some of the top exchanges have excellent customer service that can assist with almost any problem. Still, the decentralized nature of most cryptocurrencies makes resolving legal disputes nearly impossible
The lack of a central authority is one of cryptocurrency’s most risky features. However, in some countries, there is no such risk. For example, in some online financial transactions, electronic money transfer is usually backed and mediated by a financial institution. So, if there’s a problem with the transaction, investors can easily contact the authority and resolve it.
Risks Associated with Peer-to-Peer Transactions
A peer-to-peer (P2P) is a cryptocurrency marketplace that connects crypto buyers and sellers directly in the transaction process between the two-part. The peer-to-peer transaction is considered to be one of the simplest ways to convert cryptocurrency into formal currency. However, the investor factor is where mistakes can cause his or her asset to be lost. Additionally, there is also the risk of scams and fraudulent schemes; for instance, in the peer-to-peer transaction, a buyer may fail to pay for cryptocurrencies received, or a seller refuses to send the tokens.
You must bear in mind that the peer-to-peer market provides a digital asset escrow service, which is considered the best way to avoid most risks in many transactions. For instance, escrow in real estate refers to the documents and funds involved with a home sale that are held by a neutral third party until the sale is complete.
The cryptocurrencies are held by the platform during the peer-to-peer transaction using this service. The asset will be released to the buyer as soon as the buyer completes the payment process and the seller confirms receipt. This guarantees that both parties get what they want. If a disagreement arises, a platform representative or a third party will resolve it.
Risk of Losing Private Keys
Cryptocurrencies are created on a cryptographic system based on pairs of keys, which users should use to authenticate the transactions. Examples of these keys are the public key and the private key. The private keys are kept secret by users to be used for identification and authentication.
A private key is automatically generated when an investor opens a wallet and grants the user ownership of funds in that wallet.
If the investor lost his key, how can he recover lost or stolen Bitcoin? In that case, there is no way to recover Bitcoin. If a private key is lost, then cryptocurrency belonging to that key is lost.
The loss of a private wallet key means losing control or access to any cryptocurrencies in that wallet. Generally, around 20 percent of all Bitcoin lost is due to the loss of private keys. Therefore, it is crucial that an investor should regularly back up or keep his password or private key on a secure and isolated computer.
In other cases, the private keys maybe stolen. For example, on December 4, 2021, hackers breached the security of BitMart and stole various cryptocurrency tokens from customers after using a stolen privacy key to gain access to one of BitMart’s hot wallets. Many of the victims lost a particular token known as safemoon, which is a cryptocurrency token built on the Binance Smart Chain blockchain.
During an interview on CNBC television in 2021, one of the victims who invested on BitMart stated that he had 53,000 USD worth of the safemoon token stored on his BitMart wallet, 40,000 USD of which came from a loan that he had to pay back with four percent interest. This incident gives us insight into how some gamblers obtain loans to invest in risky assets, such as cryptocurrency. It is exceptionally poor financial advice to encourage an individual to borrow to invest, particularly when it involves risky assets.
Risks of Unregulated Market
The popularity of cryptocurrencies has resulted in an increase in the number of cryptocurrency exchanges and trading platforms, therefore increases in the market capitalization. Unfortunately, these developments are happening without regulation in the market. As a result, picking an exchange has become more difficult. Cryptocurrency exchanges offer the same level of services to the financial market as traditional financial institutions.
However, the lack of regulatory oversight has negatively impacted the growth by increasing the possibility of scam exchanges and market manipulation in crypto trading. Some trading exchanges have exorbitant trading fees and no policies or regulations to prevent higher trading fees, manipulative or suspicious trading, while completely unregulated exchanges may employ predatory practices.
Exchanges may charge higher commissions while also introducing withdrawal policies that make it impossible. Others may have weak security, making it simple for scammers to steal their assets.
A crucial starting point for cryptocurrency investors is to be aware that, in most countries, cryptocurrencies are not backed by any government authority. This means the consumers cannot access any government compensation for cryptocurrency losses due to fraud. Investors, therefore, need to be thorough with their due diligence as it is their responsibility to check the nature of all investment.
To learn more about the cryptocurrency and other investments, you can purchase THE FIRST INVESTOR book and receive a discount by clicking on The First Investor .