As of 2021, the market cap of cryptocurrency as an asset class has reached nearly $2 trillion, with institutional investors and companies adding Bitcoin, Ethereum, and other altcoins to their balance sheets.
But with a technology that is still less than 15 years old, many investors are worried about investing in crypto, particularly with stories of exchange hacks and stolen funds permeating the news cycle.
So, is cryptocurrency safe to invest in? Is owning cryptocurrency safe? Let’s review the basics of investing in cryptocurrency and some of the inherent risks involved to help you decide whether owning and investing in crypto is right for you.
How Safe Is Cryptocurrency?
Before we can address how safe cryptocurrency is, we need to talk about what it is.
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Cryptocurrency is a secure form of payment that can be quickly transferred from one party to another without the need for a centralized monetary system, such as a bank. Cryptocurrency transactions are cryptographically secured and recorded on a sequential public ledger known as the blockchain. This makes cryptocurrency inherently secure as a protocol.
But because cryptocurrency has no central governing authority managing it, there are very few protections in place for consumers who own it. Most places that sell cryptocurrency (known as cryptocurrency exchanges) do not offer insurance on your crypto investments the way the federal government or investment firms often insure your money against theft or insolvency of the institution holding your funds.
Overall, owning cryptocurrency is much riskier than most traditional investments, but it can still fit well in a properly diversified investment portfolio.
Cryptocurrency Risks
Cryptocurrency is built on a secure protocol, but that does not mean that owning and investing in crypto has less risks than traditional investments. In fact, as an unregulated and decentralized technology, cryptocurrency is inherently more risky than most other assets.
Here are a few of the risks associated with owning cryptocurrency.
Volatility
Cryptocurrency as an investment is one of the most volatile assets you can own. This is due to the nature of how new it is an asset class, and the sensitivity of the market to real-time news about Bitcoin and other cryptocurrency investments.
As with traditional investments, such as stocks, cryptocurrency price fluctuations are the results of market supply and demands for the asset.
For example, if there are more purchase orders for Bitcoin than sell orders, the price is driven up and demand increases, while the supply is limited to 21 million coins total (currently less than that in circulation). As more and more Bitcoin is purchased and moved off of public exchanges, the price increases further, as the supply of Bitcoin available to buy is diminished, and traders are willing to pay more per bitcoin (BTC).
Pending regulation is also one of the factors that increases the volatility of cryptocurrency in general. As U.S. regulators and other global regulations are considered, news of these policies can cause the price of Bitcoin and other crypto to swing wildly.
And finally, institutional investors, large account holders (known as “crypto whales”), and other large investors in cryptocurrency can effectively cause massive volatility in the market simply by buying or selling in large amounts.
Overall, cryptocurrency is one of the most volatile investments on the market today.
Not FDIC-Insured or SIPC-Insured
While traditional banks in the U.S. require FDIC insurance on account deposits (typically up to $250,000 per account), cryptocurrency holdings are not insured. FDIC insurance covers your deposits at FDIC member banks and compensates depositors for the full value of their balances if the bank fails (defaults).
The FDIC does not cover losses from theft or if an exchange that holds your crypto goes out of business. While some exchanges offer FDIC insurance on the cash holdings in your account, most do not offer any type of insurance on cryptocurrency holdings.
In addition, most investment firms offer SIPC insurance to cover up to $500,000 in investment holdings per account. This insurance protects against internal theft of your investments, or if the brokerage goes out of business. Cryptocurrency is not covered by SIPC insurance either, and therefore is more at risk.
This lack of government-backed insurance makes even holding cryptocurrency a riskier proposition than simply holding cash in a bank account or investments at an investment brokerage.
Hacks
Still in its infancy, cryptocurrency is (unfortunately) known for massive hacks that have drained hundreds of millions of dollars worth of cryptocurrency from user accounts. Hackers can gain access to user accounts on exchanges, to digital wallets online, or through decentralized applications that have a vulnerability.
There have been several high-profile hacks in the past decade:
- Mt. Gox exchange hack (2011 & 2014). This is the first large-scale hack that drained over $8 million in Bitcoin from Mt. Gox user accounts. In 2014, over $600 million in Bitcoin was stolen in another breach, effectively shutting down the exchange for good.
- KuCoin hack (2020). In September 2020, over $280 million in crypto was stolen from KuCoin users, making it the largest crypto hack since the 2014 Mt. Gox attack.
- UpBit hack (2019). In November 2019, hackers were able to steal over $45 million worth of crypto in a single transaction.
- Binance hack (2019). In May 2019, hackers stole over $40 million in Bitcoin from a Binance hot wallet.
While security has come a long way at crypto exchanges over the past few years, these hacks — and the lack of insurance against them — makes cryptocurrency more susceptible than most investments to online hackers.
Scams
One of the more recent negative trends to hit the crypto market over the past few years is the rise in scams that help criminals steal cryptocurrency from users. This fraud can be as simple as an email phishing scam to steal crypto exchange usernames and passwords, or as sophisticated as a fake product launch (or “rug pull”).
According to a recent study by Chain Analysis, over $7 billion worth of cryptocurrency was stolen directly from users via scams in 2021. While there are some protections you can put in place to try and avoid these scams, scams are currently one of the biggest risks crypto investors need to be aware of going forward.
Understanding how to secure your digital currency and avoid falling prey to the latest in cryptocurrency scams are essential if you are to invest in crypto.
Lost Passwords
When creating a digital wallet, users are typically asked to create a lengthy password that they must write down. Wallets are then secured with public and private keys to access the funds. In addition, most digital wallets create a randomly-generated “seed phrase,” typically a 12-word phrase used as a backup to access the wallet if the password is lost.
While having these security measures in place is a good thing to help protect you from the aforementioned scams and hacks, there are some terribly heartbreaking stories of users losing access to large amounts of cryptocurrency due to lost passwords.
In one such story, software programmer Stefan Thomas lost access to a secure hard drive that contains the private keys to over 7,000 BTC, now worth over $200 million dollars. In a recent New York Times piece, Thomas says he has tried to unlock the drive eight times, with only 10 total tries available before the hard drive erases itself.
Losing a password or seed phrase to a digital wallet can lock users out of their wallets permanently, effectively making their crypto holdings inaccessible. This is another risk crypto investors must prepare for when taking personal custody of their cryptocurrency.
Not Truly Anonymous
Although cryptocurrency allows users to make “anonymous” transactions, the blockchain is a public ledger. Anyone can track the account transactions of digital wallets on the blockchain, and in many cases, find the identity of the wallet-holder with enough sleuthing.
This makes cryptocurrency transactions not truly anonymous, which may be worrisome to some investors. While there are some cryptocurrency blockchains that provide true anonymity and privacy for transactions, the most popular crypto blockchains are still fully public and the data can be easily parsed to track transactions.
While cryptocurrency is secure, most projects are not truly private or anonymous. Holders of large amounts of cryptocurrency may not want their holdings to be public knowledge.
Cryptocurrency Advantages
While owning and investing in crypto is risky, there are some unique advantages to holding it. From fast, secure transactions to decentralized applications, there’s a lot to like. Here are a few of the advantages to using and investing in cryptocurrency:
Fast Transactions
Bitcoin and other cryptocurrency blockchains offer fast transactions with no settlement period. Both small and large transactions alike can happen in minutes, as opposed to days with traditional bank transactions.
Secure Payments
Bitcoin was designed as an extremely secure peer-to-peer payment system. Ater 13 years of transactions, using cryptography and blockchain technology, the Bitcoin network itself has never been compromised, making it one of the most secure forms of payment to exist.
Investment Growth
Cryptocurrency is a new asset class that has seen incredible growth over the past decade. Investing in Bitcoin and other crypto has resulted in huge gains, even over the past few years (although not without massive volatility). The market capitalization of cryptocurrency has risen from just $1 billion in 2013, to over $1 trillion in 2021.
24/7 Availability
Cryptocurrency transactions and trading don’t follow traditional banking hours. Users can send and receive payments 24 hours a day, 7 days a week. In addition, cryptocurrency exchanges allow trading around the clock, as opposed to traditional financial markets that are typically unavailable after business hours, on weekends, or on holidays.
New Technology
Cryptocurrency companies continue to innovate and reinvent the traditional finance industry. In addition to finance, companies are branching out into other sectors, including gaming, art, information technology, and others. Even the way the Internet operates is being fundamentally changed by the decentralized nature of cryptocurrency, with the advent of so-called Web 3.0 — a decentralized future evolution of the Internet as we know it.
How to Keep Your Cryptocurrency Safe
With all the stories of stolen cryptocurrency, it’s important to safeguard your investment by securing your cryptocurrency the right way. There are a few ways to store crypto, each with their own safety measures available to ensure your assets are as secure as possible.
Hot Wallets. Hot wallets store your cryptocurrency online. Popular digital wallets, such as Metamask, can be downloaded as an app or added as an Internet browser extension. Users can set up their own password, as well as a 12-word recovery phrase to further secure their digital assets.
Hardware Wallets. A more secure way to store cryptocurrency is with an encrypted hardware wallet, such as a Ledger. These wallets are also known as “cold wallets,” because they are not connected to the Internet, preventing would-be hackers from accessing your cryptocurrency. Hardware wallets are essentially USB drives that securely store your crypto private keys, using encryption to prevent thieves from accessing them.
Crypto Exchanges. Cryptocurrency exchanges typically have built-in hot wallets that store your cryptocurrency until you are ready to take custody of them. While exchanges are known for being targeted by hackers, they continue to improve cybersecurity, and store most user assets in cold storage (offline). Most exchanges now employ a multi-signature strategy, requiring multiple private keys to access the cryptocurrency.
Custodial Services. Some exchanges and companies offer custodial services, allowing users to store their crypto in offline servers that are monitored and physically guarded around the clock. These services are typically aimed as institutional investors and those with large cryptocurrency balances.
Overall, finding a secure way to store your cryptocurrency and following best practices, such as backing up your passwords offline and using cold storage solutions, decreases your chance of losing your crypto.
Final Word
While investing in cryptocurrency has never been easier, this new technology still has a lot of risks associated with it. In addition to the investment risk and volatility of crypto, there are many ways that your crypto can potentially be stolen or lost.
When choosing to invest in crypto, finding a reputable exchange that offers the latest in security features is a must. In addition, understanding the online and offline storage solutions that are available can help you further protect your investment.
Overall, cryptocurrency is a speculative investment, and while it can provide some diversification to your investment strategy, it is very important to do your own research and understand all the risks involved.
Source: moneycrashers.com