In recent years, Bitcoin has evolved from a novel technological innovation to a legitimate asset class with the potential to enhance almost any investment portfolio. Nevertheless, many investors still do not understand Bitcoin's risks. For example, what happens if Bitcoin’s price drops significantly? Will I have enough time to sell my holdings before I incur a devastating loss? What if Bitcoin’s value crashes to zero? What does that mean for my existing holdings? These valid questions can cause anxiety for new investors looking to diversify their portfolio with Bitcoin. Understanding Bitcoin Annual Returns can provide insights into its historical performance and volatility. This article will help ease that anxiety by discussing the risks of investing in Bitcoin and how to mitigate them to make informed investment decisions.
One tool that can help you navigate the risks of investing in Bitcoin and make informed decisions is Bitcoin Magazine Pro’s Bitcoin analysis. This resource provides actionable insights to help you understand Bitcoin’s market cycles, spot emerging trends and assess improvements in the Bitcoin network that can impact your investments.
Is Bitcoin a Good Investment?
Bitcoin has a long history of high returns, making it attractive to investors. For instance, Bitcoin surged to a new all-time high of about $69,000 in November 2021, just over a year after trading at about $10,000. Despite its volatility, early investors who bought Bitcoin even a few years ago have seen massive returns.
If you had purchased Bitcoin at the beginning of 2018, you would have gained roughly 350% of your investment by the end of 2021.
What Makes Bitcoin Unique?
Bitcoin is the original digital currency, pioneered the blockchain technology that powers all digital currencies. Bitcoin has a fixed supply of 21 million coins, which creates scarcity. Scarcity is one reason why investors believe Bitcoin can hold value over the long term.
With Bitcoin, no central authority like a government or financial institution controls the network or the currency. Instead, transactions occur directly between users on a decentralized network. This independence from traditional financial systems appeals to many investors, especially during economic uncertainty.
Bitcoin: A Possible Hedge Against Inflation?
Bitcoin proponents often claim that Bitcoin can act as a hedge against inflation, similar to gold. As the U.S. dollar loses purchasing power during periods of high inflation, many investors look to alternative assets to preserve their wealth. Bitcoin has specific properties that make it a potential store of value.
For example, Bitcoin has a limited supply, so it cannot be inflated like fiat currencies. Bitcoin is digital, portable, and easily transferable, making it a practical alternative to cash and gold.
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14 Major Risks of Investing in Bitcoin And How To Avoid Them
1. Bitcoin's Wild Price Swings: What You Should Know
Bitcoin is incredibly volatile. Bitcoin isn’t a fully functioning currency yet, so it has no fundamentals to support its price. Instead, this tradeable asset’s “fundamentals” are still emerging. The price of Bitcoin can swing wildly within a day, and even within minutes.
For instance, after hitting its all-time high of nearly $20,000 in December 2017, the price plummeted to under $7,000 by February 2018. As of this writing, Bitcoin is trading at over $50,000. Nonetheless, that’s just a number; it doesn’t mean the asset is stable. Chances are, this precipitous drop could quickly happen again.
2. Bitcoin: It's Not Money
Another reason that Bitcoin is so risky is that it is a tradeable asset but it is not backed by anything. Bitcoin has value only because the people trading it say it has value. No governments or regulatory bodies are helping Bitcoin retain its value. The value is “made up," for lack of a better word.
To put it another way, as uber-investor Warren Buffett did, “[Bitcoin] has no unique value at all." This makes it a hazardous investment if the market decides it’s no longer valuable.
3. Bitcoin: Not as Disaster-Proof as You Think
One of the biggest arguments for investing in Bitcoin during and after the pandemic is that it is an excellent hedge against fiat currency, national banks or even the entire financial system, should it fail. The pandemic made these scenarios seem more plausible than ever, but thinking that Bitcoin will be your salvation in these situations is probably false.
Gold vs. Bitcoin in a Systemic
If fiat currencies or the traditional financial systems fail, governments and central banks would respond by holding tangible assets like gold in vaults as an alternative, not Bitcoin. Also, if the collapse went even further and took down technology, electrical grids or even the entire internet, how would you access your Bitcoin then? When you hear that Bitcoin is the best way to protect yourself from future disasters, it's something to consider.
4. Cybertheft: The Dark Side of Bitcoin
Bitcoin is technology-based, which leaves this investment open to cyberattacks. Hacking is a serious risk since there is no way to retrieve your lost or stolen Bitcoins. Many reports suggest that many buyers lose their investments on exchanges and mining losses. Exchanges are more likely to be hacked even if you have the protection of a smart wallet.
If you do have a wallet and you forget or misplace your key, there is rarely a way to retrieve your coins. Carefully research your Bitcoin wallets to be sure you have the most reliable option.
5. Fraud: A Dangerous Game
In addition to hacking, there is a fair amount of fraud in the Bitcoin market. Buyers and sellers are looking to trade Bitcoins online, but since their rise in popularity, some of these exchanges can be fake.
The Consumer Finance Protection Bureau and the Securities and Exchange Commission have warned against these transactions where unsuspecting investors are duped from their Bitcoins in fraudulent exchanges. This lack of security creates a big risk for investors. While systems have been designed to deal with these problems, security remains a big issue.
6. Little or No Regulation: Invest at Your Own Risk
Currently, the Bitcoin market is operating without any significant regulations. The government doesn’t have a clear stance on Bitcoin; the market is too new. It is not taxed, making it an investment opportunity enticing. Nevertheless, a lack of taxation could lead to problems should Bitcoin pose as competition for government currency.
Currently, Bitcoin is not a widely accepted currency, but the future is ever-changing. There’s no telling what the state of the Bitcoin market could be in a few years.
7. Technology Reliance: An Investment Built on Sand
Bitcoin is an online exchange that is reliant on technology. Coins are digitally mined, exchanged via smart wallet and kept in check using various systems. Without that technology, Bitcoin is worth nothing. Unlike other forms of currency or investment, there is no physical collateral to back it up.
You own something that can be exchanged with gold, real estate, bonds or mutual funds. With a currency that is 100% technology-based, Bitcoin owners are more vulnerable to cyber threats, online fraud and a system that can be shut down.
8. Block Withholding: The Threat Within
New Bitcoins are created by solving mathematical equations called “blocks,” which are created every time there is a Bitcoin exchange online. A mining pool can use computational power to mine a block and hide it from honest miners instead of reporting the new block to the network. Essentially, this is a way for a select few to reap the benefits while others are left with nothing.
9. Limited Use: The Achilles Heel of Bitcoin
Bitcoin may be a step toward a new monetary exchange; though, few companies accept it as a viable form of currency. A few online stores, including Overstock, Newegg and Monoprix, allow Bitcoin exchanges.
Bitcoin owners can use their funds to travel with companies like AirBaltic, Air Lituanica, and CheapAir.com. Unfortunately, many companies do not recognize Bitcoin as a legitimate exchange.
10. Young Technology: A Risky Investment
Bitcoin is still a very young technology. Bitcoin came about roughly 10 years ago and has yet to become solid. With so many changes occurring in the past few years, there’s no telling how the market will evolve. As we know, Bitcoin may become useless in the future.
The best way to approach this new investment opportunity is with caution and due diligence. Take the steps to secure your funds, and brace yourself for the market's future.
11. Market Manipulation: The Influence of ‘Whales’
Market manipulation is another risk that comes with investing in Bitcoin. Unlike traditional stocks regulated by financial authorities, the Bitcoin market is largely unregulated, leaving it vulnerable to manipulation. Large investors, known as “whales,” hold a significant portion of Bitcoin’s total supply.
Market Manipulation
These whales can influence Bitcoin’s price by buying or selling large amounts of Bitcoin, often causing dramatic price fluctuations. In some cases, whales may even work together to manipulate the market through coordinated buying or selling. This could lead to artificial price increases or decreases, leaving smaller investors to bear the brunt of the losses.
The lack of transparency in the Bitcoin market means that individual investors may not always be aware of these movements or the risks they carry.
12. Lack of Consumer Protections: No Guarantees
Unlike traditional financial assets, Bitcoin investments come with very few investor protections. If your Bitcoin is stolen, there’s little recourse:
- There’s no FDIC insurance
- No fraud protection
- No way to reverse a transaction once it’s completed
This lack of consumer protection means that investors are entirely on their own regarding safeguarding their assets.
Navigating the Risks
Because Bitcoin is decentralized and operates outside the traditional banking system, there are no government oversight or safety nets. If an exchange goes bankrupt or experiences technical issues, investors could lose their money with no one to turn to for help.
This sharply contrasts the more regulated and protected world of traditional investments, where financial institutions are held accountable to consumers.
13. Environmental Concerns: The High Cost of Mining
Bitcoin’s energy consumption has become a significant point of contention in recent years. The process of mining Bitcoin, which involves solving complex mathematical problems to validate transactions, is hugely energy-intensive.
The Energy Cost of Bitcoin
According to some estimates, Bitcoin mining consumes more electricity than all countries. This has raised concerns about Bitcoin’s environmental impact significantly as the world shifts toward more sustainable energy practices.
The carbon footprint associated with Bitcoin mining has led some investors to reconsider their commitment to it. For those who are environmentally conscious, this could be a serious concern.
14. Limited Use Cases: A Speculative Asset
While Bitcoin has made strides in being accepted as a form of payment, its real-world use cases remain limited. Bitcoin is still primarily viewed as a speculative investment rather than a functional currency. The number of businesses accepting Bitcoin is growing, but it’s still far from being widely adopted as a medium of exchange.
This limited utility means that Bitcoin’s value is primarily driven by speculation about its future potential. If Bitcoin does not achieve mainstream adoption or if new technologies emerge that outperform it, Bitcoin’s value could suffer, leaving investors at risk of losing money.
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