How risky is it to trade and invest in cryptocurrency?
Did you know the first purchase made with cryptocurrency was completed on May 22, 2010? A man in Florida used 10,000 Bitcoin to purchase two pizzas from Papa Johns. In honor of this purchase, May 22 is now known as Bitcoin Pizza Day.
While many different investment options are available to investors today, cryptocurrencies like Bitcoin, Ethereum, Tether, Dogecoin, and others have gained traction since 2010. During this time, they’ve seen incredible increases in price. Both new and old investors alike are using cryptocurrency to build their portfolios.
But, as with all investments, while there is potential for gains when investing in cryptocurrency, there is also inherent risk.
If you’re considering expanding your portfolio, it’s important to understand how risky it is to trade and invest in cryptocurrency. Let’s look at what exactly cryptocurrency is and the risks and benefits associated with investing in cryptocurrency.
What is Cryptocurrency?
When talking about cryptocurrency, or crypto as it is often called, it’s important to clearly understand what it is. Crypto is a form of digital or virtual currency. Crypto is used in the name because it refers to the encryption algorithms that are used to secure different investments. Crypto allows for secure online payments.
Like other investments, the price for the different types of crypto is driven by supply and demand. This means if demand goes up more than supply, prices will also go up.
When understanding the prices, it’s important to know how supply can change.
Supply is finite for some types of crypto (Bitcoin), and there’ll only ever be a certain number of Bitcoin available. Other cryptocurrencies, like Ethereum, have no cap on how many might be supplied to the market.
In both cases, as supply and demand shift, so will the price. Understanding crypto and how it works can help you make informed investing decisions if you’re ready to add some crypto to your portfolio.
How is Crypto Traded?
If you want to trade stocks, bonds, ETFs (Exchange-traded funds), or mutual funds, you can execute the trade through your financial advisor or within your online account. While you can still trade crypto through some brokers, trading crypto typically works differently.
You’ll have to use a crypto exchange to buy or sell crypto. This is a platform where users exchange cash for cryptocurrencies. If you’re just starting out with crypto, it can be helpful to find an exchange with low fees that’s easy to use and has good security.
Once you’ve selected an exchange, your work is not yet done. You’ll need to fund your account with dollars (or another currency accepted by the exchange you’re using). You’ll use these funds to buy crypto.
Finally, if your exchange doesn’t offer a digital wallet to hold your crypto, you’ll need to select one. Be sure that the digital wallet platform you select is secure. And be sure to keep your login information safe and secure. According to the New York Times, around 20% of Bitcoin (one specific type of crypto) may be lost forever because investors can’t remember their account information to access them.
Once your account is funded and you have a digital wallet set up to hold your crypto, you can buy it on the exchange and start trading. When you’re ready to sell your crypto, you can use the exchange to facilitate your trade. You just need to find someone willing to buy your crypto in exchange for cash.
Risks of Crypto
As with any investment, crypto presents risks to the investor. Understanding these risks can help you make informed decisions about investing in crypto and how it fits into your overall financial plan. Here are a few of the risks of investing in crypto.
Crypto is Largely Unregulated
One of the risks associated with cryptocurrency is it’s largely unregulated. This means the supply of cryptocurrency tokens is not set by a central authority or government. Because crypto is still new, it’ll likely take time for policymakers to establish guidelines for regulating crypto.
Currently, the lack of regulation in the crypto sphere means it’s treated differently by different entities (the IRA treats it as property, but the Commodity Futures Trading Commission views it as a commodity). This ambiguity and difference in regulation across the board can make crypto confusing and uncertain.
It’s Possible to Lose Access to Your Crypto
Cryptocurrency is considered a technological asset. As such, you store your crypto in a digital wallet. One of the risks with the digital wallet is that it can be hacked. This means someone could get access to your digital wallet and take your cryptocurrency.
As an individual, you could also lose access to your wallet. This happens if you can’t remember your private key or enter personal information incorrectly. If you don’t have this information, you could be locked out of your digital wallet with no way to access your cryptocurrency.
Crypto is Volatile
While all investments have some level of volatility, some investments come with more volatility than others. Crypto is an example of an investment that has a large degree of volatility.
This can be seen by the fact that the price often varies widely, sometimes within a single day. In May of 2021, for example, the value of Bitcoin fell by 30% in one day. That means the value of Bitcoin dropped by roughly $30,000 in a 24-hour period. This is risky for an investor because the value of what you’re investing in can change so quickly.
Crypto isn’t Accepted at Many Locations
Selling your cryptocurrency on the exchange is straightforward. You just must find a buyer willing and able to pay the price in dollars and execute the trade. But beyond holding crypto as a store of value or selling it to get cash, few accept crypto as payment. A handful of large corporations such as Microsoft, Wikipedia, AT&T, and others will accept Bitcoin and other forms of cryptocurrency as payment. But in most cases, you’ll have to sell your crypto for cash to make purchases.
Benefits of Crypto
While there are numerous risks associated with buying and trading cryptocurrency, there are also some benefits.
Crypto has High Growth Potential
The growth potential of crypto is caused by its volatility. While the price can drop dramatically over time, it can also increase.
This high potential for growth can make it an enticing investment for some. It’s important when considering past growth in cryptocurrency to make buying and trading decisions that you remember that past performance does not predict future performance. Be just as aware of the potential loss as you are of the potential gain.
Crypto is Easily Accessible
Unlike some investing or other financial opportunities, crypto is accessible to everyone. The only requirement to begin buying and trading cryptocurrency is an internet connection. From there, you can set up an account on a crypto exchange and begin trading.
Crypto has Lower Fees and Faster Trades
Due to the nature of cryptocurrency and because it isn’t tied to any central bank, it’s typically less costly to transfer funds, especially globally. This can make it easier to move resources.
The transaction speeds are also quicker. Instead of waiting a minimum of 24 hours and in some cases 3-5 days to transfer money as you would with a bank, funds can be transferred via cryptocurrency much faster. In some cases, the transactions can even be accomplished in a matter of minutes.
So, How Risky is it to Trade and Invest in Cryptocurrency?
Since crypto is more volatile and less regulated, it represents a riskier investment than other options. While there is a large potential for growth when trading or investing in crypto, there is also more risk of loss. It’s risky to have all your money invested in just crypto. But you also shouldn’t have all your money invested in any single stock. Crypto shouldn’t be your entire investment strategy, but it can be part of a well-diversified investment plan.
When deciding to invest in or trade crypto, be sure you understand your investing goals and your time horizon. A longer time horizon when you’re investing gives you a chance to potentially recoup losses before you sell your investments. Crypto could be a viable investment option in this case if you’re comfortable assuming the risk. In addition to knowing your time horizon, identifying your goals is key. It can help you determine a risk strategy and find investment opportunities that fit within it. While cryptocurrency is a risky investment, having some as a piece of your strategy may be the right fit for you.