10 Things Everyone Should Understand Before Investing in Crypto

Despite the recent crash in cryptocurrencies, some crypto enthusiasts are looking for digital assets to recover. Bitcoin (BTC) is back above $21,000, according to CoinMarketCap, and ethereum (ETH) is above $1,200. Some of the excitement is back, and enthusiasts are likely to tell you it’s time to “buy the dip” if you want to boost your bank account in the future.

But is cryptocurrency everything it’s cracked up to be? What are some of the downsides? Before you jump on the crypto train, it’s important to understand some of the ugly truths associated with this digital asset class.

One of the biggest issues with investing in cryptocurrencies is the fact that price swings are so common. From May 2022 to June 2022, the global market cap for cryptocurrencies dropped by almost $1 trillion.

Even bitcoin, which is considered a “blue chip” cryptocurrency, fell in price from above $30,000 in early June 2022 to where it was on July 8, just above $21,000. Wide price swings are common with cryptocurrencies.

This can make it difficult to plan ahead with crypto, especially when trying to include it in your investment portfolio strategy. Some might say that investing in volatile assets is one of the strategies the 1% use during inflation, but it can be difficult to know how to use it best.

Another criticism of crypto is that it can result in a large use of resources. For example, bitcoin consumes more electricity than the country of Argentina, according to the Columbia Climate School at Columbia University. The amount of carbon dioxide put into the air from crypto is contributing to air pollution and climate change, researchers claim.

While cryptocurrencies that use proof-of-stake, which requires less equipment, consume less energy than a proof-of-work coin like bitcoin, the crypto industry as a whole makes enormous use of resources. Some cryptocurrencies, like solana (SOL), insist that they are more sustainable, using less energy and focusing on renewable energy sources.

There are a lot of scams in the world of cryptocurrency. In fact, the Federal Trade Commission reports that, in 2021, $680 million was lost to crypto fraud. By the end of the first quarter of 2022, fraud loss was already at $329 million, putting this year on pace to see fraud losses in the billions of dollars.

When learning how to buy cryptocurrency, it’s vital that you be on the lookout for scams.

Another concern with crypto is what happens as regulations change. The U.S. Treasury just released its framework for crypto regulation on an international scale. Additionally, the government is looking into developing a central bank digital currency. It’s difficult to say how regulation will impact crypto. Plus, if central banks start issuing their own digital currencies, it’s tough to say whether some cryptocurrencies will be needed.

Even if you use the best cryptocurrency exchanges, there’s no guarantee that your assets are safe. Some exchanges carry theft insurance in the event of a hack or some other security breach. However, this doesn’t protect against failure by the exchange. Plus, the SIPC insurance carried by investment brokers to protect consumers doesn’t apply to crypto exchanges and crypto assets. If the exchange fails, you could lose your money.

Watching some of the bankruptcy issues with Voyager and Celsius, it seems clear that crypto assets aren’t necessarily safe if you keep them in a custodial wallet with a company or exchange.

Despite all of the supposed protections offered by crypto wallets, they’re still hackable. The Verge has a story of how it was possible to even hack a hardware wallet. While it’s possible to get some of your assets back in some cases, for the most part, if a hacker gets access to your wallet, your coins are likely gone.

One of the ways that some people think they can make money with bitcoin and other cryptocurrencies is through a process called mining. In a proof-of-work system, computers race to solve complex cryptographic puzzles. This is called mining. If you solve the puzzle first, you receive a reward. However, mining is competitive. According to a working paper from the National Bureau of Economic Research (NBER), the largest 55 to 60 miners control about half of all bitcoin mining capacity.

If you buy expensive equipment to mine bitcoin and you face a high electricity bill, you might not be able to make your money back.

Even though cryptocurrency is sometimes hailed as a way for anyone to build wealth, the reality is that a small percentage of people control a large portion of crypto assets. For example, 0.01% of bitcoin holders control about 27% of the coins in circulation. With other cryptocurrencies, it’s also possible that whales own more than you might think, concentrating crypto wealth in a few hands.

While using a major exchange can result in a degree of liquidity for crypto assets, the fact is digital assets can be less liquid than cash and stocks. Fiat currency is extremely liquid, and stocks can usually be sold and the money deposited in your account in a few days. Cryptocurrencies, especially less popular coins, might be subject to a lock-up period, in which you can’t trade them.

Additionally, if an exchange, lender, or project runs into trouble, you might not be able to withdraw your money. Vauld is the latest crypto lender to halt withdrawals, locking up people’s digital assets.

Originally, blockchain technology and cryptocurrencies were meant to save money in fees. However, some networks have high prices, especially if the network is busy. For example, at one point, the fees to use the ethereum network, called gas, reached $50.

Anytime you use a network, you pay fees that are distributed, in part, to miners and validators. Those fees can vary, but they can cost you more than you expect. When sending or receiving cryptocurrency, it’s important to check network options. You will pay more if you want the transaction to go through faster.

Investing in cryptocurrency can be a way to build your wealth and participate in the potential of web3. However, it’s important to understand the drawbacks to investing in crypto. Additionally, consider digital assets as a speculative investment.

Some experts suggest that you limit your exposure to crypto at 5% or less of your portfolio. You might be able to find some good deals while the market is down, but that doesn’t mean your wealth is safe in crypto.

Disclosure: The author owns cryptocurrencies mentioned in this article, including BTC, ETH, and SOL.