If you are considering investing in cryptocurrency or investing on behalf of your child, it is important that you understand the risks you may be taking. Every type of investment has some risk, but some are specific to cryptocurrency or are more popular in cryptocurrency than other investments.
One of the most common risks associated with cryptocurrencies is their price fluctuations. While any financial asset can experience price fluctuations, these fluctuations appear to be more severe for cryptocurrencies than for many other investments. Take bitcoin for example. In some cases, Bitcoin prices increased exponentially before plummeting. In 2017, bitcoin prices rose from less than $800 in January to more than $20,000 in December, before falling to just over $3,300 in February 2019.
In the eight months from November 2021 to June 2022, Bitcoin prices reached highs above $68,000 and prices below $18,000, meaning the digital asset lost more than 74%, or two-thirds of its value . Even in just the 90-day period between April and July 2022, the asset fell from highs of nearly $40,000 to lows of less than $18,000.
It’s not that the stock market is immune to volatility. But even during the most severe modern recession, from its peak in October 2007 to its trough in March 2009, the stock market fell just under 50%. Federal Reserve Bank of Atlanta. “Stock Prices During the Financial Crisis.”
Another risk of cryptocurrency is its highly speculative nature. When you invest in a company, you make certain assumptions about its future success. Cryptocurrency prices, like stock prices, are determined by supply and demand. But whether a company’s stock price rises or falls often depends at least partly on investors’ perceptions of the company’s financial performance.
However, in the case of cryptocurrencies, price fluctuations can appear more arbitrary. The value of cryptocurrencies is not necessarily related to the performance of a company.
Cryptocurrencies are not necessarily regulated in the same way as other financial assets. First, the Securities and Exchange Commission (SEC) considers bitcoin a commodity. Therefore, it does not directly regulate investments in Bitcoin; however, it has jurisdiction over investment products such as funds and ETFs that invest in cryptocurrencies.
Second, although bitcoin is considered a commodity, not all cryptocurrencies are classified this way. In fact, the SEC believes that many cryptocurrencies sold through initial coin offerings (like initial public offerings or IPOs) may be securities that must be registered with it.
Just like there is a lack of clear regulation for cryptocurrencies, there is also a lack of regulation for crypto exchanges. The exchanges and brokerage firms where you buy stocks must meet certain regulatory standards. However, cryptocurrency trading platforms do not fall under these regulatory frameworks.
Fraud and scams exist in all financial markets, but they are especially prevalent when it comes to cryptocurrencies. And the lack of regulation makes the risk of fraud even greater.
If you’re considering investing in cryptocurrency, it’s important to keep an eye out for warning signs that could be a sign of a scam. Signs of a scam can include being pressured to buy a specific cryptocurrency or new asset with no history to consider. In general, if it sounds too good to be true, it probably is.
Securities Investment Protection Corporation (SIPC) protects investors’ money in brokerage accounts. If the broker goes bankrupt or ceases operations, SIPC will compensate investors for their losses.