Risks of Cryptocurrency Investments

What is Cryptocurrency

Every year, more people are turning their attention to digital currencies. Investments in cryptocurrency attract interest with the promise of high returns, but they also come with significant risks. Before deciding to invest, it is essential to understand what cryptocurrency is and how it works.

Cryptocurrency is a digital asset that exists solely in electronic form. It has no physical representation (coins or banknotes) and lacks a central governing body. This new type of electronic money operates on the basis of blockchain technology: transaction information is stored in a distributed network of computers (nodes). Thanks to cryptographic protection methods, it is practically impossible to hack or counterfeit transactions. No bank or government agency manages the issuance of cryptocurrency; instead, the emission and accounting are carried out automatically according to set algorithms.

For most people, cryptocurrency is primarily of interest as a financial instrument. Beginner investors should first understand the basics of the crypto market: comprehend what cryptocurrency is and how it functions. By grasping the principles of blockchain operation and the specifics of digital coins, investors can make more informed decisions and understand what results to expect.

What is Cryptocurrency Used For?

Initially, cryptocurrencies were created as a means of payment—an alternative method for purchasing goods and services online. They allow money to be sent directly from the sender to the receiver without the involvement of banks. For example, using Bitcoin, money can be quickly transferred abroad, bypassing high bank fees. Additionally, cryptocurrencies are used for capital preservation: some investors view them as "digital gold" and invest funds to protect against inflation.

Another use case is investing in cryptocurrency for profit. Various approaches are possible here. Some prefer trading, attempting to capitalize on short-term price fluctuations. Others bet on the long-term growth of leading coins. In any case, the objective is the same—to generate income by using cryptocurrency as an investment tool. As the industry evolves, new opportunities have emerged, such as decentralized finance (DeFi) and smart contracts, allowing for additional income from token ownership.

What Determines the Price of Cryptocurrency?

Cryptocurrency prices are highly volatile and can change multiple times within a day. The price of cryptocurrency primarily depends on supply and demand in the market. If many want to buy a specific coin, its value rises; conversely, if there is a dominant desire to sell, the price drops. Demand is influenced by the project’s popularity and utility. For instance, well-known coins with larger communities (Bitcoin, Ethereum, etc.) enjoy more stable demand than lesser-known tokens.

News and public sentiment also play a crucial role. Positive news (launching new technology, support from a major company) attracts investors and drives the price up. Negative events (exchange hacks, regulatory bans) repel investors and trigger price drops. For example, the year 2017 is remembered for the excitement surrounding cryptocurrencies: within a few months, their total capitalization skyrocketed. However, soon after, the market experienced a significant downturn as many projects failed to meet expectations and regulators in several countries announced potential bans.

The limited issuance and internal economics of cryptocurrency projects also influence prices. Some currencies have a capped supply (like Bitcoin, limited to 21 million coins), creating scarcity and sustaining value. Other tokens are continuously issued, and their price may decline due to inflationary pressure. Thus, the price of cryptocurrency is shaped by a multitude of factors—from the technical features of the network to investor behavior in the market.

What is Cryptocurrency Staking?

Simply put, staking in cryptocurrency refers to the ability to earn passive income by holding coins. In other words, staking is akin to a bank deposit: the investor retains a certain cryptocurrency in a special account (wallet or exchange), and in return, receives rewards. The rewards are earned by supporting the functioning of the blockchain network—validating transactions and ensuring its security. This process is applicable to cryptocurrencies that use the Proof-of-Stake (PoS) consensus algorithm, where coin holders participate in transaction validation.

Staking yields vary depending on the specific cryptocurrency and platform. Usually, it ranges around 5–10% annually, although for certain tokens, it can reach even higher values. It is important to understand that during staking, the coins remain the property of the investor but may be locked in the account for a specified period. If there is a need to sell the coins urgently, it cannot be done until the locking period is over. Furthermore, rewards for staking are credited in the same cryptocurrency, so actual profit depends on the token’s market price.

How Much Can You Earn from Cryptocurrency?

The cryptocurrency market is known for stories of unexpected wealth—many dream of making millions from it. Indeed, one can achieve significant profits from digital coins, as their price can multiply rapidly within a few months. However, it is unwise to expect easy income. How much can be earned from cryptocurrency depends on numerous factors: the timing of purchases, the quality of the project, and overall market conditions.

Much of the outcome is determined by the investor's strategy. Short-term investments in cryptocurrency through trading can yield quick profits if the price surge is timed correctly. However, this approach comes with elevated risks—the price may move against expectations at any moment. Conversely, long-term investments in cryptocurrency involve holding coins for several years, awaiting substantial increases in their value. This method requires patience and belief in the prospects of the chosen project. Ideally, one should combine both approaches: allocate the majority of funds to long-term positions in reliable cryptocurrencies while using a smaller portion of the portfolio to experiment with short-term trading to enhance overall returns.

It is important to remember that past successes do not guarantee future profitability. The cryptocurrency market is cyclical: periods of rapid growth are followed by prolonged declines. Within a short time, capital can be multiplied, while during other periods, recovering investments becomes challenging. Hence, any forecast of earnings in cryptocurrency is merely an approximate estimate. Experienced investors advise entering the market gradually and not risking amounts that one cannot afford to lose.

Taxes on Cryptocurrency

Earning profits from cryptocurrency transactions, like any other income, is subject to taxation. In Russia, as of the writing of this article, there is no separate tax on cryptocurrency, but profits from its sale are considered personal income. Consequently, income tax (personal income tax) applies to this amount. The income tax rate is typically 13% in most cases. For very high incomes, it increases to 15%.

It is important to correctly calculate the taxable base. For example, if you bought Bitcoin for 1 million rubles and sold it for 1.5 million rubles, the profit constituted 500 thousand, and income tax of 13% should be paid on this difference. Transactions exchanging one cryptocurrency for another can also be viewed as a sale resulting in income. While legislation is evolving, failing to declare profits from cryptocurrency can lead to problems with tax authorities. Therefore, honestly fulfilling tax obligations is part of the financial discipline of any investor.

It should be noted that tax regulations vary depending on the country. In some jurisdictions, cryptocurrencies are taxed like investments in stocks or other securities. If you plan to actively engage with cryptocurrencies and earn substantial profits, make sure to study the applicable tax regulations in your jurisdiction or consult with a tax professional.

Risks of Investing in Cryptocurrency

Any investment carries the possibility of losses, but the risks associated with cryptocurrency investment are particularly high, as potential returns and risks are directly correlated—higher potential profits come with greater risk. Consequently, the investment risk for those choosing cryptocurrency is immensely greater compared to traditional financial instruments. The main risks associated with cryptocurrency can be categorized into several areas:

High price volatility. The price of Bitcoin and other coins can drop sharply within days. Such unpredictability signifies significant loss risk: an investor can lose a substantial part of their capital due to unfavorable market movements.
Lack of guarantees and regulation. Cryptocurrencies are not regulated by the government as bank deposits or securities. If a wallet is hacked or an exchange goes bankrupt, recovering funds is nearly impossible—these risks remain with the investor.
Fraud and scam projects. The crypto industry has its fair share of fraudsters: one may encounter a fake ICO, Ponzi scheme, or malicious application. Without proper due diligence, an investor risks putting money into a project that could disappear along with their funds.
Technical risks. Handling cryptocurrencies requires a responsible approach. Losing private keys to a wallet results in losing access to the coins. Software errors or hacker attacks on smart contracts can also lead to financial losses.

The aforementioned dangers should not completely deter one from working with digital currencies, but they cannot be ignored. A prudent approach entails risk assessment and management: avoiding putting all funds into one cryptocurrency, using secure services, and implementing protective measures (hardware wallets, two-factor authentication, etc.). Thus, cryptocurrency is a tool with a high risk level, and the risks for investors are extremely significant. An investor must be prepared for any surprises.

Advantages and Disadvantages of Cryptocurrency

Advantages of Cryptocurrency

High income potential. Cryptocurrencies can appreciate in value by tens or even hundreds of percent, yielding substantial profits for investors. Early investments in promising tokens can result in exponential returns.
Portfolio diversification. Adding cryptocurrencies to an investment portfolio provides an opportunity to invest in an alternative asset that is minimally correlated with the traditional market. This can enhance overall investment stability and yield profits when other instruments stall.
Decentralization and freedom. Cryptocurrencies are not controlled by banks or governments, granting owners financial independence. Transactions occur directly between participants, with minimal fees and no intermediaries.
Low entry threshold. It is possible to start working with cryptocurrencies with small amounts, making them accessible to a wide range of investors. There is no need to purchase a whole coin—one can buy a fraction, such as 0.001 BTC, and gradually increase investments.

Disadvantages of Cryptocurrency

High risk of loss. Volatility and lack of guarantees imply that an investor may lose a significant portion of their investments. Such financial risks deter conservative market participants.
Lack of regulation. The legislative framework for cryptocurrencies is still in a nascent stage. In the event of problems (theft, fraud), there is no one to protect the owner's rights—neither banks nor the government take responsibility for lost cryptocurrency.
Complexity and technical barriers. Safely handling cryptocurrencies requires a certain level of knowledge. Newcomers may find it challenging to navigate the multitude of new terms, set up wallets, and ensure key security. Mistakes can result in loss of funds, and identifying the causes of issues can be difficult.

Should You Buy Cryptocurrency?

So, we have examined the main characteristics and risks of the crypto market. The remaining question is: should one buy cryptocurrency? There is no universal answer: the decision depends on your financial goals, investment horizon, and willingness to take risks. Cryptocurrency is a high-risk asset, and such speculative investments are not suitable for everyone. If you are accustomed to conservative instruments such as bank deposits, the volatile rises and falls of digital coins may come as an unwelcome surprise.

On the other hand, a small investment in leading cryptocurrencies may be justified, especially if viewed as long-term. If you believe in the development of blockchain technologies, it makes sense to allocate a small portion of your capital to cryptocurrencies. The key is not to invest money that would critically impact your budget if lost. Experts recommend including cryptocurrency in your portfolio in moderation (for example, no more than 5–10% of total investments) and carefully selecting projects for investment.

For novice players, it’s important to proceed gradually. If the decision is made to enter a new market, the question arises: where to start investing in cryptocurrency? It begins with choosing a reliable platform for purchasing and storing coins. A clear investment strategy is needed: determine the amount you are willing to invest, the time frame, and the conditions under which you will exit your position. And remember: once you invest your funds, keep an eye on news and developments related to the chosen projects.

Ultimately, cryptocurrency can be an intriguing addition to an investment portfolio, but it should not be viewed as a guaranteed path to wealth. After assessing the risks that this market poses to investors and comparing them with the potential benefits, each individual must decide whether it is worth playing this game. The key is to approach such investments wisely and cautiously.

What Risks Do Investors Face When Staking Cryptocurrency Assets?

Staking attracts attention with the prospect of passive income, but investors must also understand its pitfalls. Firstly, while your coins are locked up in staking, their market price continues to fluctuate. If the price suddenly drops, the investor's financial risks will become fully apparent—the earned interest may not offset the decline in the coin's value. Secondly, many projects impose fixed lock-up periods for staking funds. This means that you will not be able to withdraw and sell your coins instantly, even if the market begins to decline sharply. Such low liquidity can lead to missed opportunities or increased losses.

Additionally, there are counterparty risks: when you entrust your cryptocurrency to a third-party platform for staking, there is a significant chance of encountering an untrustworthy service or being targeted by hackers. If the platform turns out to be fraudulent or gets hacked, reclaiming your funds will be exceedingly difficult. Another consideration is technical network upgrades. Sometimes during major blockchain updates, the staking process may be disrupted, and rewards will not be accrued temporarily, even though the funds remain locked.

Finally, don’t forget about taxes: rewards received from staking are considered income and are subject to declaration under the general rules (as described above). Therefore, investors carry nearly the same risks as with standard coin ownership, with some specific nuances. Weigh all the pros and cons, and if you decide to engage in staking, choose reliable projects, distribute funds across different platforms, and avoid investing in obscure tokens for questionable high yields.