Investing in Cryptocurrency: 6 Reasons to Proceed with Caution

Investing in cryptocurrency has been a popular topic for the past few years. Some people have made millions upon millions of dollars while the majority of people have lost most (if not all) of their money. Let me explain to you why investing in cryptocurrency can be a dangerous addition to your portfolio and if you are going to do it, make sure to do it responsibly.

What is Cryptocurrency?

This one topic could be an entire financial college course. But let me do what I can to explain what cryptocurrency is and how it works in just a couple paragraphs.

Cryptocurrency is a digital payment method that is built on a new type of technology called blockchain. 

When you purchase something from someone else and you pay with it using a cryptocurrency, there is no centralized bank or financial institution to verify the transaction and take a fee. Instead the “ledger” that says that you paid someone else some money is recorded on the blockchain technology. 

That record of your purchase is not controlled by a central bank or financial institution. Instead it is recorded by everyone using that technology. 

I know it is a little confusing (or maybe a lot confusing) but understanding the intricacies of how crypto works is not the focus of this article. Instead, understanding if it is a good investment or not is important.

Now that we have that out of the way, there are some really important things to understand about investing in anything (crypto included).

Cryptocurrencies and Volatility

I have spoken at length several times about the balance between risk and reward and volatility in investing. 

The less risk that you take in your investments, the lower the reward, and the more risk you take, the higher potential reward.

Are you afraid to invest your money at all because you might lose it? That’s cool. Put it in a savings account at your bank. But you won’t get a high interest rate because you are not willing to put that money at some level of risk.

But on the other hand, if you want TONS of risk, crypto fits the bill.

Investing in cryptocurrency tends to have a lot more volatility than a traditional investment into something like the S&P 500.

What this means is the ride will have higher highs and lower lows.

For example, if the S&P 500 gains 3%, a particular cryptocurrency might gain 6%. And if the S&P 500 loses 4%, a particular cryptocurrency might lose 8%. 

Of course these are hypotheticals, but you get the idea. There are a few reasons for the higher level of volatility in the crypto market:

• The entire crypto industry is starting to mature. Some cryptocurrencies have been around now for more than a decade.
• It is largely unregulated.
• There is a limited market size (meaning that most investors do not purchase them).
• There is a LOT of speculation.
• Most people do not understand blockchain technology.
• Cryptocurrencies are decentralized and operate independently of any central authority.

But with all this being said thus far. I would still not tell someone to not invest in a cryptocurrency. You have to make that decision for yourself. However, you should proceed with caution.

Problems With Investing in Cryptocurrency

If you want a spicy flavor in your investing portfolio, crypto might be a way to get that. But make sure that you watch yourself. Because there are some big potential problems that you need to consider when investing in crypto.

Pump and Dump Schemes

One of the problems with investing in cryptocurrency is that there is an unusually high number of pump and dump schemes.

A pump and dump scheme is when an investment’s price is artificially increased with false or misleading information. Then when the price is high, the originators of the scheme sell their shares and make a boatload of cash.

In fact, in 2022, nearly 24% of all new cryptocurrencies were later to be found out as pump and dump schemes.

So buyer beware.

Scams

Scams are another big problem with investing in crypto. In fact, nearly 22% of cryptocurrencies that have gone defunct since 2013 have been because they were some type of scam.

Buyer beware again.

No Purpose or Joke Currencies

Ever heard of Dogecoin? Dogecoin was created as a complete joke and took off to nearly 11,000% increase! However, it was short lived and came crashing down.

With no actual value or purpose, investors started to panic and bailed out (among other reasons).

Buyer beware for a third time.

Little to No Trading Volume

There are so many cryptocurrencies that are started all of the time, there would be no way to keep up with them all. In fact, there are more than 22,000 cryptocurrencies out there.

There are simply too many to consider when investing. And because of this about ⅔ of all cryptocurrencies that go defunct, are because there is simply no trading volume.

So if you are looking at buying some crypto and you find one that looks like it has just started and you think you might be able to get in on the ground floor and ride it to the moon, think again.

There is a much higher likelihood that you will lose all of your money on that investment.

Buyer beware x4.

Little Government Oversight

This one cuts both ways. On one hand, a large reason that many investors invest in crypto in the first place is because of the lack of centralized government oversight.

However, that also has drawbacks. If the government were to pass legislation negatively affecting the crypto market, you could risk losing a lot (or maybe all) of your money.

I don’t know what the future holds in the crypto market and the proposed legislation, but you should be aware that it could affect your portfolio.

Should You Invest in Cryptocurrency or Not?

The short answer is, “I don’t know”. It depends on you. What are your investment goals, risk tolerance, debt load, income, age, etc.

But here are some guidelines to consider when investing in the crypto market.

1. If you are going to invest in crypto, be prepared to lose ALL of your money. I hope it doesn’t happen, but it might. The crypto market is young and is surrounded with a lot of uncertainty (as I’ve already discussed). If you are going to invest in this then do it with extra money that you have and you could afford to lose.
2. Make sure that you do the bulk of your investing in your retirement accounts. Those investments have a proven track record and are far better understood. Rely on your 401k or other retirement accounts to do the heavy lifting of your portfolio.
3. Stay away from cryptocurrencies that look like pump and dump schemes or that have been released in the past year. Give them time to shake out and for some of them to go bankrupt without your investment.
4. Do not have more than a MAXIMUM of 5% of your portfolio in crypto. If you have more than that then you are WAY too risky.
5. Do not take out debt to pay for crypto. If the investment that you make goes belly-up, you still are responsible for the debt. Don’t make a crappy situation even worse.

Final Thoughts

At the end of the day, I think that having a small amount of crypto in your portfolio is not a bad thing. In fact, I have some in mine. It only accounts for about 0.75% of my total portfolio though. 

And if I lost every penny of it tomorrow, I would be a little ticked off. But my world would not change.

Have that kind of mentality when investing in cryptocurrency.

I am here for you!

You can do this!

Until next time!