An investor should not be mistaken or confused about the fact that cryptocurrency investing is extremely risky. While record returns-on-investment and an endless chain of online hype make altcoins look like the must-invest vehicle, the reality is that there are as many stories of altcoin investors losing it all as there are stories of successes, if not more. To a certain extent, in light of the growing number of altcoin scams and hacks, altcoin investing is equal parts of preparation, bravery, and acceptance of pain.
Understanding the risks, however, is the first step in mitigating them. This article looks at what the most common risks in altcoin investing are and what an investor can do to prepare for them.
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Understanding What an Altcoin Is
Most of the risk in altcoins are self-explanatory, once you consider what exactly an altcoin is. While there are variations from coin to coin, in general, an altcoin is a virtual currency that exists and is actuated via a distributed ledger or a distributed ledger-like network (as in the case of EOS). It may or it may not be decentralized (meaning that it is controlled by a consensus protocol and not a singular company or authority), it may or it may not be monetized, and it may or it may not be public.
Let’s look at each of these variables separately:
- Decentralization: A risk factor lies in whether the altcoin is internally or externally-controlled. Ripple, for example, is a privately-controlled altcoin that serves as the token for the company’s real-time remittance, transmission, and settlement service. As it is privately-held, there is no consensus mechanism or a means for the community to weigh in on currency decisions. This can be considered both a positive and a negative. While private-controlled blockchain avoids the “Byzantine Generals’ Problem,” which dictates that forming a consensus can be a challenge or even impossible if there is a “bad actor” intentionally seeking to break consensus, it also denies democratic limits that would prevent a singular majority shareholder from intentionally discriminating against the minority.
- Monetization: A monetized altcoin is, by design, a speculative event. This both makes these types of coins prone to huge ROIs, but also to significant market turbulence. On the other hand, a non-monetized altcoin which represents an investment or a share in a commodity may – in itself – be recognized as a commodity, subject to both existing and future regulations. As these regulations are being formed now, it is unclear how they may affect future investing or if they may ban future investments outright.
- Public versus Private: Some altcoins are publicly sold and traded from their ICOs, while others were offered in private sales or “whales-preferred” ICOs. While publicly-offered altcoins are likely to have an ownership base that has interests and investing perspectives similar to yours, privately-offered altcoins will have a majority held by institutional investors and by large portfolios. The two offer different views on consensus-building and on priorities for long-term growth, with one being community-oriented and the other being profit-oriented.
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The challenges in altcoin lie in the fact that:
- Altcoins are not universally accepted. While most G7 nations have legalized (or, at least tolerate) altcoins, there are ambiguities in how they are treated under the law. Some take a hands-off approach, while others treat them as taxable commodities. Some argue that they are money, while others ban them outright. Some permits personal use, but ban institutional use, while others permit both, but ban banks from being involved in the sale of them.
- Transferring altcoins from an area that accepts altcoins to one that does not can be construed as trafficking.
- There is no international standard for altcoin regulations. This means, from nation to nation and sometimes state to state and town to town, the rules on altcoin use can change.
- Altcoins are considered intangible and therefore have no rules to protect possession. Like a bearer bond, legal possession is defined by who currently possess the altcoin’s private keys. This has led to a rash of theft and scams.
- Altcoin rules can and will change. Also, in the same nation, there can be conflicting regulations for altcoin use by the banking authority and the financial authority.
Your risk avoidance strategy should consider both variable and non-variable risks, such as the nature of the coin, exchange and vendor security, data security, wallet safety, market insecurity, and regulatory ambiguity. Bitcoin Market Journal offers guides that go into each of these in greater detail, but in general:
- Protect passwords, private keys, and personal data. Invest in offline storage options, use two-factor authorization when offered, and avoid using mobile devices for accessing or storing wallets.
- Vet any and all vendors. This includes wallet providers, exchanges, news aggregators, and charting/analysis services. Know what their customers say about them, understand their customer service and grievance processes, and be aware of any hidden fees or requirements.
- Know the rules and laws for your jurisdiction. They will change often and quietly in regards to altcoins, so do not assume that you know the current policy. When in doubt, look it up.
- Do not dump all of your money in a single investment. Consider pairing off your investments so that there is an altcoin available to absorb and counter downturns in your primary altcoin’s pricing. Develop a gradual method of investing to avoid price spikes and have an exit strategy ready.
- Stay knowledgeable on market activity and on the coins in which you choose to invest. You can never have too much information.
- Go slow. Trust your instincts and get out if you feel uncomfortable. Move at your own pace and no one else’s. Finally, only invest what you feel comfortable losing.
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