Crypto Risks vs. Benefits: Balancing the Ledger

By Kirk David Phillips, CPA, CMA, CFE, CBP

Before we get into crypto risks and benefits, here's a quick lesson in what crypto is and how it works.

Cryptocurrency is a digital asset that uses encryption for security. It operates on a decentralized network called a blockchain, which records all transactions. No single entity controls crypto, making it different from traditional currencies. The blockchain uses complex algorithms to validate transactions and maintain network integrity. People are incentivized to participate in securing the network through crypto rewards. 

Having even a basic understanding of crypto risk and security is critical to your long-term crypto success. 

What are the main risks with cryptocurrency?

So you're interested in crypto but you're weighing the risk vs. reward? While many focus on crypto's volatility and consider it too risky, it's important to note that all assets have some level of volatility. Unfortunately, the volatility narrative leads people to dismiss crypto altogether and miss out on opportunities.

So let's start by addressing the crypto risks head on because the crypto landscape does present a unique blend of familiar and novel risks to consider:

• Traditional investment risks - The crypto market is subject to common investment risks, including market volatility, regulatory changes, political influences, technological advancements, operational challenges, and liquidity concerns. These risks are familiar to experienced investors but may manifest differently in the crypto space.
• Novel technological risks - Unique to the crypto world are risks associated with smart contract vulnerabilities. These are essentially software bugs that can potentially lead to substantial financial losses. The complexity of blockchain technology introduces new types of risks that traditional investors may not be accustomed to.
• Amplified traditional risks - Some risks common to traditional investments are magnified in the crypto space. For instance, market volatility tends to be more extreme, and regulatory uncertainty is often more pronounced due to the rapidly evolving nature of the industry.
• Potential risk reductions -  Interestingly, crypto reduces risk in certain areas compared to traditional investments. A prime example is the elimination of counterparty risk in peer-to-peer transactions, as blockchain technology enables direct transfers without intermediaries.

So keep these risk factors in mind as you continue to navigate crypto, but don't be dismayed or deterred. Keep in mind that any asset class will inherently carry risk.

"The essence of investment management is the management of risk NOT the management of returns."

- Benjamin Graham, godfather of value investing and mentor to Warren Buffett

What are the negative effects of crypto?

While cryptocurrencies offer numerous benefits, there's certainly a downside of crypto that cannot be ignored. Some of these disadvantages include:

• Fraudulent schemes - Ponzi schemes and rug pulls target unsuspecting investors, promising unrealistic returns or disappearing with funds.
• Market manipulation - Large holders can influence prices through pump-and- dump schemes or sudden profit-taking, affecting smaller investors.
• Illicit activities - Crypto's pseudonymous nature may attract illegal transactions, though research shows only 1% are linked to illicit activities.
• Economic shifts - Crypto's growing popularity could disrupt traditional financial systems, challenging established institutions.

These factors highlight the perceived negativity in crypto. However, the industry is evolving to address these issues. Efforts are underway to develop more secure platforms, implement stricter regulations, and enhance transparency. As the industry matures, many of these negative effects may be mitigated.

Why are people so against crypto?

Despite its popularity, a significant faction in governments and the financial sector are opposed to crypto because it challenges the status quo. Critics often highlight seemingly legitimate reasons why crypto is bad to stifle this innovative technology.

Jamie Dimon, CEO of JP Morgan Chase, is a notorious naysayer whoʼs been calling Bitcoin a fraud for more than a decade. He even stated he would fire anyone who uses crypto.

Dimon said:

“I call it a pet rock.ˮ

“If you're stupid enough to buy it, youʼll pay the price for it one day.ˮ

Meanwhile Larry Fink, CEO of Blackrock and a Dimon contemporary, is leading the charge with the largest Bitcoin ETF since the US SEC approved Bitcoin ETFs in 2024. Now there are dozens of Bitcoin ETFs yet Dimon continues to spew misleading information.

Then there's Nouriel Roubini, a world-renowned economist, who's been spewing negative stuff about Bitcoin for as long as Dimon.

Roubini said:

“Bitcoin price will crash to zero.ˮ

“Crypto is the mother or father of all scams and bubbles.ˮ

These very intelligent successful people simply donʼt understand Bitcoin and crypto and/or donʼt want to understand it. Bitcoin is disruptive technology, so itʼs no surprise legacy finance and economists are threatened by it.

These are just a few examples of the many people who feel threatened and overreact. They have a large mainstream audience who give them credit no matter what they say. This type of narrative can block people for a long time because they donʼt know whom to trust.

“It's hard to get a man to understand something when his salary depends on him not understanding it." - Author Upton Sinclair 

Is it safe to invest in crypto?

Investing in crypto involves weighing potential benefits against risks. While it offers opportunities, it's crucial to be prepared and aware that you are your own custodian.

Key advantages to investing in crypto include:

• High potential returns - Bitcoin's value has grown from cents to thousands of dollars.
• Self-custody - Users can control assets without intermediaries, particularly valuable in unstable economies.
• Accessibility - Available to anyone with internet, potentially serving the unbanked.
• Transparency - Public blockchains allow transaction verification.
• Innovation - Driving advancements across various sectors.

Important crypto investing risks to consider:

• Volatility - Extreme price fluctuations can lead to significant gains or losses.
• Regulatory risks - Government regulations can impact crypto's value and usability.
• Technical complexity - Safely managing crypto requires some technical knowledge.
• Market manipulation - The market's relatively small size makes it susceptible to manipulation.
• Fraud and scams - Various fraudulent activities exist, though not unique to crypto.

Investment safety depends on your risk tolerance, goals, and understanding of the technology. Many financial advisors consider crypto high-risk and may not recommend it due to firm policies or lack of incentives.

Key Takeaway

Only invest funds you can afford to lose. This is true for all investments because nothing is guaranteed.

How does crypto make you money?

Cryptocurrency can generate returns through various methods:

Trading

Actively buy and sell cryptocurrencies, similar to securities trading. Profit from market fluctuations by timing purchases and sales. Requires in-depth market knowledge and constant monitoring of trends. 

Airdrops

Receive free tokens from blockchain projects as part of their marketing strategy. Potentially lucrative but requires active participation and staying informed about upcoming airdrops. Be cautious of scams.

Staking

Earn rewards by holding and "staking" coins to help secure the network. This process involves locking up your crypto assets for a certain period to support blockchain operations and earn passive income. 

Yield farming

Generate returns by lending or staking crypto on DeFi platforms. This involves providing liquidity to decentralized exchanges or lending protocols to earn fees and additional tokens.

Mining

Earn rewards by validating transactions and securing the network through computational power. Requires specialized equipment (like ASICs for Bitcoin) and technical expertise. Consider electricity costs and hardware depreciation. 

Key Takeaway

NEVER invest more than you can afford to lose. This is investing 101 and it's just as critical in crypto. Start small, test the waters, and build up as you gain experience.

Which crypto to avoid?

Not all cryptos are created equal; some pose greater risks than others. When evaluating which crypto to avoid, it's crucial to conduct thorough research.

Cryptocurrency examples of projects that have failed or been deemed scams include Bitconnect and OneCoin, which have left many investors at a loss.

Investors should be wary of cryptos that exhibit the following red flags:

• Lack of transparency - Projects that don't provide clear information about their team, technology, or roadmap should be approached with caution.
• Unrealistic promises - Be skeptical of cryptocurrencies promising guaranteed high returns or risk-free investments.
• No clear use case - Avoid cryptocurrencies that don't solve a real problem or serve a specific purpose in the blockchain ecosystem.
• Centralized control - Projects with a high concentration of tokens held by a small number of wallets may be susceptible to manipulation.
• Poor code quality - For those with technical knowledge, reviewing the project's code (if open-source) can reveal potential vulnerabilities or poorly implemented features.
• Lack of community engagement - A strong, active community often indicates a healthy project, while a lack thereof might be a warning sign.
   

Key Takeaway

It's also important to be cautious of "pump and dump" schemes, where the price of a cryptocurrency is artificially inflated through influencers and project promoters, before being "dumped" by the perpetrators at a profit. This can be hard to identify when it's happening.

Stay informed about crypto risks and benefits

To stay informed about minimizing risk while maximizing returns in the ever-evolving world of crypto, be sure to subscribe to the latest intel. By educating yourself about cryptocurrency risks and benefits, you can make informed decisions that align with your financial goals and risk tolerance.