Cryptocurrencies: What They Are and How Much Risk They Carry
Introduction
Few investments stir up as much passion as cryptocurrencies. To some, they are the future of money; to others, a speculative bubble. Caught in the middle are millions of people who bought in because a friend made a fortune, because they saw it on social media, or out of fear of missing out, without really knowing what they were buying.
This article does not aim to convince you either to buy or to avoid cryptocurrencies. It aims for something more useful: helping you understand what they are, why their prices swing so wildly, and what concrete risks they entail, so that any decision you make is an informed one.
If you do not understand where the profit in an investment comes from, the profit is probably coming from you.
What a Cryptocurrency Is
A cryptocurrency is a digital asset that runs on a blockchain: a public ledger of transactions maintained by a network of computers, without a central bank controlling it. The first was Bitcoin, described in a 2008 paper signed under the pseudonym Satoshi Nakamoto, whose network went live in January 2009.
Since then, thousands of cryptocurrencies have emerged. Some aim to serve as a medium of exchange, others power application platforms such as Ethereum, and still others—known as stablecoins—attempt to maintain a fixed value pegged to a traditional currency like the U.S. dollar.
Where Their Value Comes From
Unlike a stock, which represents ownership in an earnings-generating company, or a bond, which pays interest, most cryptocurrencies generate no cash flows. Their price depends on how much other people are willing to pay for them, which in turn depends on confidence in their future utility, their scarcity, and speculative demand.
This does not mean they cannot hold value, but it does explain why their fair price is so hard to estimate and so sensitive to shifting expectations.
Volatility, in Numbers
Cryptocurrencies have experienced spectacular rallies and equally dramatic crashes. Bitcoin, the most established cryptocurrency, fell roughly 77% between its November 2021 peak and November 2022. It was not the first time: it had suffered drops of similar magnitude in earlier cycles. Smaller cryptocurrencies have lost virtually all of their value.
To put that in perspective: a 77% drop turns $1,000 into $230. To get back to the original value, the price has to more than quadruple.
Risks Beyond Price Swings
Platform risk. Many people do not hold their cryptocurrencies directly, but leave them on crypto exchanges. If the exchange goes bankrupt or gets hacked, the funds can be lost. The best-known example is FTX, once one of the largest exchanges in the world, which filed for bankruptcy in November 2022 and left millions of customers locked out of their funds.
Design risk. In May 2022, TerraUSD—an algorithmic stablecoin that was supposed to hold a steady $1 value—collapsed. Within a few days, it lost nearly all its value alongside its sister token.
Self-custody risk. Anyone who stores cryptocurrencies in their own digital wallet relies on private keys. If you lose those keys, there is no bank customer service desk that can recover them.
Scams and fraud. The crypto space is fertile ground for fraud: pyramid schemes, fake investment platforms, impersonations of public figures, and promises of guaranteed returns.
Regulatory risk. Rules vary from country to country and change over time, affecting how crypto assets can be bought, sold, or taxed.
Questions to Ask Before Buying
Before buying any cryptocurrency, you should be able to answer honestly:
- What problem does this project solve, and who actually uses it?
- Who is behind it, and how transparent are they?
- Where and how am I going to store it?
- What would I do if it were worth half as much tomorrow?
- Am I buying because I understand it, or because other people are making money?
If the answer to the last question is the second option, your decision is probably driven by emotion rather than analysis.
If You Decide to Invest
If, after understanding the risks, you decide to hold cryptocurrencies, follow a few prudent rules:
- Only invest money you can afford to lose entirely without derailing your life goals or your peace of mind.
- Keep it to a small fraction of your net worth, and only after you have a full emergency fund, high-interest debts paid off, and long-term retirement savings underway.
- Use regulated, reputable platforms with two-factor authentication enabled.
- Distrust any promised or guaranteed return.
- Learn how crypto is taxed in your country.
Common Mistakes
Buying out of fear of missing out (FOMO). This usually happens right near market peaks.
Investing your emergency fund or borrowed money. Volatility can wipe it out in weeks.
Trusting an influencer or a social media "advisor."
Leaving everything on a single platform without researching it.
Confusing interesting technology with a good investment. A technology can be useful while its token still loses value.
Conclusion
Cryptocurrencies are young, highly volatile digital assets with no intrinsic cash flows, surrounded by platform, fraud, and regulatory risks. At most, they can occupy a small corner of an already well-ordered portfolio—never its foundation. Before buying any cryptocurrency, write down in a single sentence where the return would come from and how much money you are willing to lose without affecting your life. If you cannot answer both clearly, it is not time to invest yet.
References
- Nakamoto, S. (2008). Bitcoin: A Peer-to-Peer Electronic Cash System. bitcoin.org.
- Bank for International Settlements (2022). The future monetary system. BIS Annual Economic Report 2022, ch. III.
- U.S. Securities and Exchange Commission. Crypto assets: Investor alerts and bulletins. investor.gov.
- International Monetary Fund (2021). Global Financial Stability Report: The Crypto Ecosystem and Financial Stability Challenges, ch. 2.