What are My Risks When Buying/Holding Cryptocurrencies?
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7m There are several risks associated with buying or holding cryptocurrency coins/tokens. Some of the most significant risks are:
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- Liquidity Risk: Crypto markets can be illiquid, meaning that it can be difficult to buy or sell large amounts of a particular crypto quickly, especially for tokens on non-custodian DEXes like Uniswap/Pancakeswap. Because pairs pool can be created arbitrarily and their liquidity does not have a minimum limit, this can make it hard to exit a position or realize profits.
- Smart Contract Risk: Interacting with a smart contract on a blockchain also carries huge risks. Some of the main risks associated with interacting with smart contracts are:
- Bugs in the code: Smart contracts are self-executing codes that cannot be modified once uploaded. These bugs can trigger unintended tasks that can result in tremendous losses for investors.
- Hacking: Smart contracts are extremely flexible, and capable of controlling large amounts of value and data, while running immutable logic based on code deployed on the blockchain. This not only has created a vibrant ecosystem of DeFi but also represent opportunities for attackers looking to profit by exploiting vulnerabilities in smart contracts. In fact, a 2018 study found that 1 in 20 smart contracts are at risk of being attacked. It is estimated that the total amount of value stolen or lost due to security defects in smart contracts is easily over $1 billion. This includes high-profile incidents, such as the DAO hack (3.6M ETH stolen, worth over $1B in today’s prices), Parity multi-sig wallet hack ($30M lost to hackers), and the Parity frozen wallet issue (over $300M in ETH locked forever).
- For instance, in 2016, the infamous The DAO Attack took place where a hacker found and exploited a bug in the smart contract. They discovered that you could request funds multiple times before the contract registers it and updates the balance, allowing the hacker to request significant amounts again and again. This led to losses to the tune of millions of dollars worth of ETH (actually 14% of total supply of ETH) and forced the Ethereum community hard-forked a new Ethereum chain we are using today. The attack highlighted the dangers of smart contract vulnerabilities and prompted blockchain developers to be more cautious in reviewing their code to ensure its security.
- Regulatory Risk: Cryptocurrencies are still a relatively new and unregulated asset class. Governments around the world are beginning to develop regulations, but the rules are still evolving, and it's unclear how they will affect the cryptocurrency market in the long term. Learn more: Global crypto regulation report 2023 by PwC
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- Volatility Risk (Specific Risk / Alpha Risk): Due to the lack of liquidity (small market size), regulation, trading hours (24x7), and price limits (no limit up or down), the price volatility of cryptocurrencies can be extremely high, which can lead to rapid depreciation of holdings, especially for some meme coins, whose lifespan may end in just a few hours (from skyrocketing prices hundreds of times over to zero) due to severe illiquidity.
- Market Risk (Systematic Risk / Beta Risk): The overall market sentiment can affect the price of cryptocurrencies. Bitcoin and Ethereum are the benchmarks of crypto market for now, dominating 41% and 18% of the whole market respectively. Global financial policies, regulatory news and negative reports, etc. may lead to a decline in demand, which will lead to a decline in cryptocurrency prices.
- Wallet Security Risk: Cryptocurrencies are stored in digital wallets, which can be vulnerable to hacking, theft, and other forms of cybercrime. If your wallet is compromised, you could lose all of your funds. Learn more about crypto wallet incidents from crypto wallet security incidents 2022 yearly review by Certik. It reveals huge impact incidents like Slope's improper handling of private keys and metamask's iCloud backup, etc.
It's important to understand these risks and DO YOUR OWN RESEARCH (DYOR) before investing in cryptocurrency. Additionally, you should always use secure digital wallets and employ good security practices to minimize the risk of loss due to hacking or theft.
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