What Are the Main Risks if You Want to Invest in Crypto?
Several investors make crypto out to be not entirely safe, while others are raving that it's here to stay. Let's explore the advantages and risks of investing in cryptocurrency.
Interest in cryptocurrencies has grown considerably since the first of them, Bitcoin, was created in 2009. In 2016 alone, its exchange rate increased by more than 300 percent. Cryptocurrencies are now a rapidly developing alternative to today’s payment systems and banks. ATMs for cryptocurrency transactions exist in Western countries, and virtual currencies have long been available for sale and purchase on the Internet. Bitcoin can even be used to buy a plane ticket or pay for university tuition. In addition, many well-known financial analytical companies have begun to track fluctuations in the rate of cryptocurrencies and predictions on investments.
Advantages of Cryptocurrencies
Such popularity is due to the many advantages of cryptocurrencies. For example, it is an easy start – there is no complicated registration, age or any restrictions. All you need is Internet access. You download the Bitcoin client to your smartphone or computer, it generates your wallet address and from that moment you can accept and send currency.
The second is that there are no intermediaries for transactions, such as correspondent banks, which significantly reduces the time and cost of the transaction and reduces the risk of errors.
The third advantage is that the source codes of Bitcoin are in the public domain and anyone can study them to make sure that the program only performs the stated functions and nothing else. This system does not depend so much on human factor, trust in controlling authorities or issuer has been replaced by mathematics, algorithms and cryptography.
These are just the main advantages of cryptocurrencies, in fact they can be listed for a long time. Like any other means of payment, Bitcoin, even though it is not a secured currency, is integrated into the existing economy. And that means, like everything else, it carries certain risks. While many people see a promising future for the cryptocurrency, unexpected rate hikes make even seasoned investors seriously wary.
So, what are the risks to consider when investing in virtual currency?
Risks of Investing in Cryptocurrencies
If some miscreant gains access to an investor’s private secret key, he can steal absolutely the entire contents of the digital wallet. And if this, in general, can be dealt with by keeping secret keys offline – so-called “cold storage” – there is another problem. Users of virtual currencies have lost access to their secret keys – and, as a result, their Bitcoin wallets – in the past owing to unforeseen circumstances or their own ignorance. A computer hard disk can crash, and one wrong move can result in the erasure of the secret key file.
One of the most significant dangers is that the virtual currency Bitcoin is not secure in any manner. Every sovereign currency in the world is fully backed by government assets. The assets of the corporations that invented electronic currencies are used to back them up. Cryptocurrencies, on the other hand, do not require any kind of security!
Hackers can hack into virtual currency trading platforms. For example, one of the largest cryptocurrency exchanges, Hong Kong-based Bitfinex, was hacked in August 2016 and 119,756 BTC, or $72 million, was stolen, leading Bitcoin to drop 23% instantly. The hacker managed to get beyond Bitfinex’s security measures, including two-factor authentication and a multi-signature system, resulting in a huge withdrawal from individual wallets of the cryptocurrency exchange’s users, according to Zane Tackett, public relations manager at Bitfinex.
Another telling example is the case of digital currency exchange platform Cryptsy, which lost 13,000 BTC and 300,000 LTC in a hack on July 29, 2014. But the most interesting thing is that it did not even inform its users about it because it did not want to cause a mass panic.
One of the most recent high-profile cases is the hacking attack on the South Korean exchange Bithumb, in which hackers stole several billion South Korean won worth of BTC from customer accounts. Bithumb is the largest Bitcoin exchange in South Korea and the fourth largest exchange worldwide. It accounts for 75.7 percent of all payment transactions in South Korea. The Bithumb exchange has a turnover of approximately $33 million per day, equivalent to one-tenth of the world’s total Bitcoin turnover. Hackers reportedly stole the personal data of 31,800 users of this exchange – about 3 percent of the entire customer base. As you can see, even such a large exchange can be hacked.
Since Bitcoin’s creation, its acceptance has grown exponentially, making it the most popular virtual currency used around the world. Unfortunately, as the popularity of cryptocurrency grows, so does the number of scammers attempting to profit from it.
When someone promises them a guaranteed high yield, for example; offers to buy Bitcoins when no one has offered to sell them; when the sale or purchase is too appealing; or when unknown persons try to create a false sense of urgency to invest, thereby not leaving enough time for calm reflection, potential investors should be wary. Unfortunately, both virtual and real-money transactions carry this danger.
Phishing is also a popular way to scam virtual currencies today. Phishing is probably one of the most common ways cybercriminals get personal information from users. Scammers often use emails where they ask trusting users to click on some links or enter their confidential information, such as wallet or email passwords, under a variety of pretexts. Fraudsters often masquerade as well-known resources by copying their design.
For example, one of the largest cryptocurrency web wallets in the world, Coinbase, has been phished since 2014 and still is. In the fall of 2016, the TrickBot Trojan was discovered and spread through email spam, which also targets Coinbase.
A little earlier, in July 2016, after the disappearance of Bitcoin mining company HashOcean with millions of dollars in BTC, phishers attempted to get victims to part with their funds by claiming they could get back the stolen BTC. Wanting to entice gullible victims, phishers used email newsletters and fake Facebook pages and websites.
To avoid becoming a phishing victim, do not open untrusted sources. Also, as the experts of the aforementioned Coinbase advise, make sure that the operating system and important software on your computer is always updated to the latest versions. Avoid installing applications from dubious sources and do not use “hacked” versions of official software.
Bitcoin, however, does not provide any consumer protection. Transactions that have already been executed cannot be undone. After a botched transaction, all you can do is try to persuade the recipient of the funds to return it voluntarily. This is due to the lack of a guarantor-intermediary, as there is in the case of bank cards.
Bitcoin transactions are comparable to cash transactions in that there are only two parties involved. However, the fact that transactions are irreversible and there are no intermediaries has an impact on the attractiveness of Bitcoin as an asset. However, investors should be aware of the flip side of the coin.
In the near term, Bitcoin’s value changes are completely unforeseeable, which contributes to its riskiness. Financial specialists can forecast the value of the dollar, euro, and other actual currencies, as well as stock values, with reasonable accuracy. However, no one can anticipate how much Bitcoin will be valued tomorrow.
Some specialists are attempting to do so in the long run. In a recent analysis, for example, Chappuis Halder & Co. predicted that Bitcoin will equal fiat currencies in terms of volatility by 2019. The report’s writers attempted to develop a model that would allow them to forecast Bitcoin’s value. For other assets, similar models already exist.
. The experts found that Bitcoin will have a bright future in the next years, but that success will be marred by speculation and rate volatility. Cryptocurrencies are viewed as a new asset type that may be utilized as cash and storage for investments, according to the paper. The market, however, still needs time to learn about and accept Bitcoin, according to the report’s authors.
High volumes of exchange trading, regulatory activities, integration of the virtual currency with other companies, and other factors all contribute to Bitcoin’s price volatility. Furthermore, financial and economic specialists who follow the cryptocurrency market point out that the Bitcoin exchange rate is quite sensitive to news stories.
The technology component frequently evolves at a breakneck pace, sometimes uncontrollably. Everyone is aware that Bitcoin has and will continue to have a large number of competitors on a daily basis. Despite the fact that Bitcoin is the most well-known and widely used cryptocurrency, there is a very real technological danger that another, more advanced virtual currency will arise. It’s possible that investors will miss the point at which their virtual funds lose their real value.
Every country now regulates cryptocurrencies in its own unique way. The absence of a unified regulatory framework for cryptocurrencies further adds to the uncertainties surrounding their future. Many countries’ regulators are concerned that Bitcoin and other cryptocurrencies could be used for speculative purposes, money laundering, terrorist financing, and other illegal activities. With the growing popularity of cryptocurrencies, governments in many countries are stepping up their efforts to regulate the circulation of Bitcoin and other virtual currencies through a variety of legislative proposals.
For example, in Ukraine, the Verkhovna Rada recently registered the country’s first draft law on the circulation of cryptocurrencies, developed with the assistance of the Ukrainian Blockchain Association. The bill proposes to entrust the National Bank of Ukraine to regulate the market of virtual currencies in the country. It will have to develop an operating procedure for cryptocurrency exchanges. Income earned by such exchanges will be taxed. Taxes will have to be paid from the namained cryptocurrency, but the mechanism of taxation has not yet been determined. But in this case the government will not have any obligations to owners of cryptocurrency (i.e., it does not provide it as a classic currency, in case of depreciation or loss of the cryptocurrency the government will not help its owner in any way).
And on October 10 another bill was registered by Serhiy Rybalka – “On Stimulation of Cryptocurrency Market and its Derivatives in Ukraine”. In this bill virtual money is already recognized as a financial asset, not an object of exchange, as it was in the previous one. Accordingly, cryptocurrency exchanges will have to obtain a license for their activities and will be entitled to open accounts in cryptocurrency both residents of Ukraine and foreigners.
Also in the second bill on cryptocurrencies more clearly spelled out tax obligations of cryptocurrency exchanges. They will be required to pay an additional fee for pension insurance from the purchase and sale of virtual currencies, and then will have to report to the Pension Fund.
At the same time, it was proposed to introduce some incentives for miners. For example, reduced electricity rates for those who mine cryptocurrencies at night.
Countries that have introduced regulation of virtual currencies also include Switzerland, Japan, USA, Canada, UK and others. China has banned ICOs (Initial Coin Offering) altogether, declaring that 99 percent of ICOs are fraudulent schemes.
In Singapore, according to the Deputy Prime Minister, the regulator has not recognized Bitcoin as a means of payment, so the control will be exercised over the companies that provide services for the sale of Bitcoin, but not the cryptocurrency itself. At the moment, the financial regulator is developing new payment rules, which will eliminate the risks of money laundering and terrorist financing associated with the anonymity of payments through virtual currencies.
The situation is quite different in Australia. The Australian government intends to make Australia a world leader in FinTech. It was announced about the temporary legislative relaxations that allow foreign initiators to ICO in Australia, to work and test new financial technologies for up to two years without licensing. The International Organization for Standardization (ISO) has even appointed Australia to head the international standards development committee for blockchain technology (ISO/TC307). So now it is Australia that develops the rules of the blockchain game.
This factor stems from the previous one. Investors who intend to invest in cryptocurrency should also consider that there is considerable uncertainty about the taxation of circulation of virtual currencies in different countries. In certain jurisdictions, cryptocurrencies are considered an asset, while in others they are not.
In Israel, for example, the Internal Revenue Service decided in early 2017 to recognize Bitcoin as a commodity, making transactions far more complicated and imposing a slew of taxes. Individuals must pay a capital gains tax of 25% when selling BTC. They must prove the cost of obtaining the virtual money; otherwise, they will be required to pay tax on the entire sale. And because trading and mining virtual currencies is now considered a form of business, organizations engaged in these activities must pay income tax and levy a 17 percent VAT on their clients.
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