Did You Know About These Cryptocurrency Pitfalls?

Between the stories we see on the internet, the countless memes, and the growing library of buzzwords, it's hard to research today's economy without running into some references to cryptocurrency. According to the FTC, cryptocurrency is a type of digital currency that exists electronically.¹ You can use crypto as you would cash in many scenarios. You can invest in it, use it to buy things, and keep it in your (digital) wallet.

But as with any investment or currency, there are a few pitfalls to consider before jumping headlong into the world of crypto. Here, we outline some of the most significant drawbacks to consider as you research crypto.

Cryptocurrency could be a sound investment for one person and not a good fit for another. To understand whether it's right for you, let's look at five of crypto's pitfalls.

1. Lofty Promises

It's difficult to find an article about cryptocurrency that doesn't contain some hyperbolic claims about the currency's performance. An article from Bloomberg shares some tweets from bitcoin fanatics that say crypto will be the world's biggest benefactor is the "only monetary asset ever, has saved lives, and may one day hit $100,000 or even $1M a share."²

To an uneducated investor, all of these claims might sound like magic. But, as with any asset, it's important to remember that we can't see into the future, and we have no idea how it will perform in the coming years. Approach these claims as hesitantly as you would those regarding any other asset.

2. Crypto Isn't FDIC-Insured

Another pitfall is that cryptocurrency accounts aren't backed by the government like traditional bank accounts. There are some third-party companies where you can store your digital wallets, but if something happens to those companies, the government has no obligation to step in to help get your money back.

In addition to not being backed by government protection, most cryptocurrency payments don't come with legal protections like credit or debit card purchases do. If you need to dispute a purchase you made using crypto, the process could be long and complicated, if not impossible. In addition, most purchases using crypto aren't reversible. This lack of purchase protection and insurance could be a deal-breaker to some.

3. Crypto May Be Less Secure

Because your currency is stored online, crypto comes with some inherent security risks, both on- and off-line. For example, there's always the risk of cybersecurity breaches, hacking, fraud/market manipulations, and other technological risks.

Just as important, there are also human error risks that one should consider before purchasing crypto. What would happen if you forgot your password or someone stole your laptop? How would you access your digital wallet? The New York Times famously covered the story of Stefan Thomas, a German-born programmer who had two attempts remaining to guess the password to his digital wallet worth $220 million at the time of writing.³ Cryptocurrency and digital wallets give a new meaning and horror to the prompt "Forgot your password?"

4. Crypto Has Major Environmental Impacts

Even though cryptocurrency is digital, mining for crypto has real-world impacts. Mining requires huge amounts of electricity, and while electricity itself is a relatively clean source of energy, the countries with the highest rates of mining burn fossil fuels to generate electricity. According to the Cambridge Bitcoin Electricity Consumption Index, mining for Bitcoin uses more power globally than entire countries, including the Netherlands, the Czech Republic, and Pakistan.⁴ And that's just for Bitcoin, which is a single form of crypto. Mining for Ethereum generates more than 62.9 million tons of carbon dioxide emissions, the same amount as Serbia and Montenegro combined.⁵ According to Digiconomist, a single Bitcoin transaction uses as much power as it takes to run the average US household for over 78 days.⁶

This environmental impact is a major consideration, especially as more investors are moving in the direction of environmental, social, and governance (ESG) investing.

5. Crypto Still Has to Prove Its Case

Lastly, cryptocurrency is still relatively new and needs more time to prove its case. You can buy more things with crypto now than you could in past years, but you can't buy everything with crypto. In March 2021, Elon Musk said that Tesla would accept Bitcoin as payment but later stated that the company would no longer accept Bitcoin, due to its environmental impact.⁷ This is just one example of the instability of using crypto as a payment method.

Cryptocurrency is a major player in today's economy, but it's worth taking time to consider its drawbacks before jumping in. If you decide to invest in crypto at all, consider it a speculative asset, only investing dollars you are ok with losing. It can be helpful to speak with your financial planner prior to making these sorts of decisions to make sure how you invest is in line with your financial plan.

This content is developed from sources believed to be providing accurate information. It may not be used for the purpose of avoiding any federal tax penalties. Please consult legal or tax professionals for specific information regarding your individual situation. The opinions expressed and material provided are for general information, and should not be considered a solicitation for the purchase or sale of any security.