Like other investments, cryptocurrencies pose certain risks—for example, they could lose some of or all their value, and they may not provide the return you anticipate. But cryptocurrencies by their very nature pose an exceptional level of risk for a number of additional reasons:
While essentially all investments rise and fall in value, cryptocurrencies are particularly volatile, both in terms of the significant shifts in value over short periods of time and the speed at which the changes occur.
Let's look at two recent boom and busts.
The price of Bitcoin rose from $5,564 on Oct. 26, 2017 to an all-time high of nearly $20,000 on Dec. 17, 2017. That is an increase of some 360% in two months. But less than two months later, the price had fallen back to $6,846. That’s a fluctuation in value of more than $26,000 in a little over four months—for one Bitcoin.
More recently, at the beginning of 2019 Bitcoin price's was $3,715. By mid-July, fueled in part by speculative giddiness over Facebook's proposal of an online payment system backed by its own cryptocurrency, named Libra, the price of one Bitcoin was $12,575. That is an increase of 238%. Sure enough, by August 2019 the price of Bitcoin had dropped by nearly $3,000.
Lack of Liquidity
Investments like Treasury issues and highly traded stocks are liquid—you can readily convert them to cash. That’s not the case with a cryptocurrency. If there is little or no demand for it, you risk being locked into holding it longer—and possibly much longer—than you want, unable to get the cash you might need in a timely way.
When a security is thinly traded—which means there is not a robust market of buyers and sellers—it may be difficult to sell the virtual currencies you have at a price you are comfortable with, provided you can sell them at all. The lower the volume, the greater risk you run of having to sell at a loss.
Virtual currencies trade on unregulated exchanges, making them vulnerable to trading irregularities. These include possible price manipulation by major cryptocurrency investors or even by the trading platform itself as well as spoofing or similar fraudulent activity that may affect prices. Some Bitcoin exchanges have been hacked, resulting in millions of dollars of losses. As an investor, you can never be sure you are getting a fair or best price, and the exchanges themselves could potentially be vehicles for the clandestine and possibly illegal movement of funds.
While wallets and private keys, as well as blockchain technology, are designed to insure the security of cryptocurrency transactions, there is the possibility that virtual currency accounts can be hacked or subject to malware, resulting in the theft or loss of your cryptocurrency holdings. Trading virtual currencies on exchanges may not be secure because of weaknesses in the platforms. There is no insurance to cover the loss of virtual currency—if the accumulated tokens and their value disappear, they are simply gone. And if you forget your private key, there is no way to retrieve it, so you have no way of accessing your cryptocurrency holdings.
Same Old Scams
Fraudulent cryptocurrency offerings have taken their place alongside imaginary gas and oil wells, fabricated promissory notes and overseas investments, among others, as the basis for a new raft of scams. The allure of cryptocurrency-related scams relies on the same hooks as more traditional schemes: get in on the ground floor, don’t miss out, there’s no real risk, you’re guaranteed high returns, and why settle for low returns when you could be earning so much more.
Even the promotions are similar—online ads, social media, public solicitations, and personal, family, or group connections—along with the failure to mention the very real risks involved. Sadly, the outcome is mostly the same—investors left with worthless or non-existent holdings and significant, often irreplaceable losses of their hard-earned, much-needed money.
Of particular concern is crypto marketing, a scheme in which promoters of securities tied to cryptocurrencies recruit investors to pitch the investments, often to friends and family and through social media and blogs. In return, these investors are promised a generous return plus the promise of commissions on their sales. The problem, of course, is that investors are not licensed to sell securities, and are therefore in violation of securities regulations and subject to significant penalties.
If you are approached with a cryptocurrency offering or have any doubts about the legitimacy of the offering or the representative who is promoting it, be sure to contact the Enforcement Division at (512) 305-8392 or email@example.com
Next up: Cryptocurrency scams.
The Investor's Guide to Cryptocurrency Offerings was funded by a grant from the Investor Protection Trust and written in collaboration with Lightbulb Press.