Dramatic gains are possible, but so are devastating losses, and investors should understand crypto’s wide-ranging risks. Here’s an overview of crypto volatility risk, technology risks, regulatory uncertainty and other issues that could 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, bitcoin’s price dropped 30%, after the Chinese government cracked down on bitcoin mining and trading.
Crypto prices may also rise and fall based on diverse factors such as changing public sentiment, world news, mainstream adoption, protocol upgrades, impending regulation, hacks, scams and more. Plus, crypto is a relatively new asset class, and the market is still in the process of price discovery.
Technology risks
Cryptocurrencies’ underlying blockchain technology is built with numerous security measures, including decentralization, cryptography and consensus mechanisms to confirm that transactions are legitimate. However, no blockchain is immune to every threat.
Backing up your crypto wallet regularly and storing it safely helps to protect you against computer failure, device theft and your own mistakes—such as accidentally uninstalling your digital crypto wallet. But it’s harder to guard against threats such as software bugs, data glitches and 51% attacks (when a group of crypto miners takes control of more than half of a network’s computing power).
Crypto investors and developers are also concerned about advances in quantum computing, the next generation of computer technology. Its potential computing power could allow bad actors to hack crypto wallets, forge transactions or rewrite parts of a blockchain to alter transaction records. If that were to happen, crypto values would likely plunge—even get wiped out. That day is likely still several years away, but Ethereum and other crypto organizations are already working on post-quantum cryptography.
Low liquidity
Liquidity means how easily and quickly you can exchange an asset for cash. Cryptocurrencies—especially smaller, newer ones—tend to be less liquid than other investments like stocks and bonds. That means trading or cashing in your digital coins may not happen as quickly as you’d like, even though crypto markets around the world operate nearly around the clock.
As a result, you might get “slippage”—a difference between the price you expect and the price you get once the trade has been executed. Slippage can happen if the bid/ask spread—the gap between what buyers are willing to pay and what sellers are willing to accept—changes while you’re waiting for your trade to be filled, perhaps even several times. When the actual price is lower than what’s expected, your buying power increases; this is called “positive slippage.” When the actual price is higher than expected, your buying power decreases; this is called “negative slippage.”
