Every investment we want to venture into has risks. Cryptocurrencies are not exempted.
To become successful, you have to be intentional about your actions and understand the things you can control and the ones you can’t control.
The 7 Biggest Risks for Crypto Investors (Both Beginners and Veterans).
Here are some risks you have to be aware of to avoid falling for any of them and to help you make wiser investment decisions.
- Smart Contract
- Composability
- Execution
- Key Man
- Ecosystem
- Competition
- Legal and Regulation
Smart Contract
A smart contract is a self-executing agreement that runs on a blockchain and executes transactions according to predefined rules and conditions. Smart contracts enable various functionalities in the blockchain applications, such as lending, borrowing, trading, and governance.
However, smart contracts pose significant risks, such as coding errors, security vulnerabilities, and malicious attacks. If a smart contract is faulty or compromised, it could result in financial losses, data breaches, an opportunity to hack a network, or network disruptions for the users and the protocol.
For instance, in October 2023, Platypus protocol was hacked about $2.2m due to swap slippage manipulation. The swap slippage in Platypus depended on the convergence of the coverage cash liquidity ratio in the asset contract. So, the attacker manipulated the cash and liability in the contracts to gain an incentive from swap slippage.
Composability
Composability is the ability of different protocols and components in the crypto ecosystem to interact and work together seamlessly. Composability enables innovation and efficiency in the crypto space, as it allows developers to build new applications and services by combining existing ones.
For example, users can borrow funds from one protocol, swap them for another asset on another protocol, and stake them on a third protocol, all in one transaction.
However, composability also introduces systemic risks, as it creates interdependencies and cascading effects among protocols. If one protocol fails or malfunctions, it could affect the performance or security of other protocols that rely on it.
For example, in February 2020, bZx, a DeFi protocol that provides lending and margin trading services, suffered two attacks that exploited its composability with other protocols. The attackers used flash loans from dYdX and Uniswap to manipulate the prices of certain assets on bZx and profit from arbitrage opportunities.
Execution in Crypto
This is the process of carrying out transactions and operations on a blockchain network. Execution depends on various factors, such as network congestion, transaction fees, block size, and confirmation time.
It can pose challenges and risks for crypto investors, as it affects the speed, cost, and reliability of their transactions.
If the network is congested or the transaction fees are too high, investors may face delays or failures in executing their trades or transfers. This could result in missed opportunities or losses due to price fluctuations or contract expiration.
For example, in May 2021, Ethereum experienced a spike in network activity and gas fees due to the launch of Uniswap v3, a significant upgrade of the popular decentralized exchange protocol. Many users reported difficulties or failures in executing their transactions on Ethereum-based protocols due to the high demand and costs.
Key Man in Crypto
This is the risk that a crypto protocol depends heavily on one or a few individuals who are essential for its development, operation, or security.
If these key persons leave, die, or get compromised, the protocol could suffer from disruption, loss of trust, or attack.
The death of Gerald Cotten, the founder and CEO of QuadrigaCX, a Canadian crypto exchange, in 2018. Cotten was the only person who had access to the exchange’s cold wallets, where most of the customers’ funds were stored. His death resulted in the loss of about $190 million (CAD 250 million) worth of crypto assets and triggered a legal dispute and investigation.
Blockchain Ecosystem
This is the risk that a crypto project faces from the interactions and dependencies among various components and actors in the crypto space. These include other projects or protocols, platforms, services, users, developers, regulators, and so on.
The crypto ecosystem is complex and dynamic, and changes or events in one part can have ripple effects on others.
In 2020, a series of hacks and exploits targeted several DeFi protocols that were built on Ethereum, such as Harvest Finance, bZx, and Pickle Finance. These incidents caused millions of dollars worth of losses for the affected protocols and their users, as well as increased congestion and fees on the Ethereum network.
Another example is the ban on crypto mining and trading by China in 2021, which had a significant impact on the global crypto market. The ban reduced the hash power and security of Bitcoin and other proof-of-work cryptocurrencies, as well as the supply and demand of crypto assets.
Competition
This is the risk that a crypto project or protocol faces from other existing or emerging protocols that offer similar or superior features, services, or value propositions.
Competition can erode the market share, profitability, or innovation of a protocol, as well as its network effects and user loyalty.
This can reduce the potential ROI of investors as a competitor with a better product would take away liquidity from the existing protocol an investor invested in.
In 2021, Solana (SOL), a blockchain platform that claims to offer high scalability, low fees, and fast transactions, gained a lot of popularity and adoption among users and developers.
Solana was seen as a strong competitor to Ethereum, which was struggling with scalability issues and high gas costs. Solana’s rise also challenged other Ethereum alternatives, such as Binance Smart Chain (BSC), Polygon, Avalanche, etc.
Legal and Regulation
This is the risk that a crypto project or protocol faces from the laws and regulations that apply to its activities, operations, or jurisdictions. Legal and regulatory risks can arise from uncertainty, inconsistency, or hostility from authorities regarding the status, treatment, or oversight of crypto assets and activities.
When a project crypto investors invest in is going through legal and regulatory issues, it can affect the increase in the price of the coin as the narrative is negative. Instead, this negative narrative can make the price of the coin plummet, causing investors to lose their money.
Although the SEC dropped the lawsuit against Ripple, since they had an ongoing lawsuit with the SEC, their cryptocurrency didn’t pump much as compared to the 2018 bull run, where it reached an all-time high of $3.4.
Legal allegations are bad for investors. Whether medium or long-term investors. You want to invest and make a profit without any friction in your investments.
I have two Simple Strategies to make money in crypto quickly. You do not have to hold a cryptocurrency for a long time before you see your capital and profit.
The longer you hold a cryptocurrency, the probability that any of these risks will affect it.
The strategy is simple. I included factors that make a cryptocurrency a good investment for short to medium-term profit.