CRYPTO INVESTMENT RISKS

What are the key risks investing in crypto assets?

1. You could lose all the money you invest

• The performance of most crypto assets can be highly volatile, with their value dropping as quickly as it can rise. You should be prepared to lose all the money you invest in crypto assets.
• The crypto asset market is largely unregulated. There is a risk of losing money or any crypto assets you purchase due to risks such as cyber-attacks, financial crime and firm failure.

2. You should not expect to be protected if something goes wrong

• The Financial Services Compensation Scheme (FSCS) doesn’t protect this type of investment because it’s not a ‘specified investment’ under the UK regulatory regime – in other words, this type of investment isn’t recognised as the sort of investment that the FSCS can protect. Learn more by using the FSCS investment protection checker here.
• Protection from the Financial Ombudsman Service (FOS) does not cover poor investment performance. If you have a complaint against an FCA regulated firm, FOS may be able to consider it. Learn more about FOS protection here.

3. You may not be able to sell your investment when you want to

• There is no guarantee that investments in crypto assets can be easily sold at any given time. The ability to sell a crypto asset depends on various factors, including the supply and demand in the market at that time.
• Operational failings such as technology outages, cyber-attacks and comingling of funds could cause unwanted delay, and you may be unable to sell your crypto assets at the time you want.

4. Crypto asset investments can be complex

• Investments in crypto assets can be complex, making it difficult to understand the risks associated with the investment.
• You should do your own research before investing. If something sounds too good to be true, it probably is.

5. Don’t put all your eggs in one basket

• Putting all your money into a single type of investment is risky. Spreading your money across different investments makes you less dependent on anyone to do well.
• A good rule of thumb is not to invest more than 10% of your money in high-risk investments. Learn more here.

If you are interested in learning more about how to protect yourself, visit the FCA’s website here. For further information about cryptoassets, visit the FCA’s website here.

What are the risks associated with different crypto assets?

Remember, not all cryptoassets are alike. Before investing, you should ensure you understand the specific risks involved.

Stablecoins

‘Stablecoin’ (e.g. USDC, USDT) is the term often used for crypto assets that claim their value is linked to certain reserve assets such as a fiat currency (e.g. US Dollars).Stablecoins may use a range of different ways to maintain stability, each with their own risks.  

• Counterparty risk: Where the asset is backed by collateral (e.g. fiat currency) you are relying on a third party to maintain that collateral which introduces risk if the party becomes insolvent or fails to maintain the necessary collateral.  
• Redemption risk: If the asset claims to be redeemable for underlying collateral, there is a risk that the redemption process will not work as expected e.g.  in times of market volatility or due to operational issues.
• Collateral risk: There’s a risk that the value of the collateral could decline or become volatile, affecting the stability of the asset (e.g. where the collateral is another type(s) of crypto asset(s)).
• FX risk: Lots of stablecoins are denominated in US Dollars, meaning you will be exposed to movements in the exchange rate between US Dollars and your local currency, e.g. USD: GBP for users in the UK.
• Algorithm risk: If the asset relies on an algorithm to maintain stability (e.g. by adjusting supply based on demand) there’s a risk the algorithm could fail or behave unexpectedly, which might cause the asset to lose its stability and even lose all its value. 

DeFi tokens

Decentralised Finance (or ‘DeFi’) tokens (e.g. UNI, AAVE) are crypto assets linked to financial applications and protocols built on decentralised blockchain technology.  

• Smart contract risk: DeFi relies heavily on smart contracts. Even a minor coding error or oversight can lead to a contract being exploited, potentially resulting in significant losses for DeFi tokens.
• Regulatory risk: DeFi operates in a decentralised manner, often without intermediaries or financial crime controls. Regulatory bodies across jurisdictions might introduce new regulations impacting the use, value, or legality of certain DeFi protocols or assets.
  • For example, the Perpetual Protocol (PERP) and Quickstop (QUICK) protocols may be accessible in jurisdictions where some or all the available activity may need to be regulated now or in the future. If a regulator deemed the activity to be in breach of regulation, this could seriously impact token value.
• Rug-pulls / Exit scams: Some DeFi projects might be launched by anonymous or pseudonymous teams, increasing the risk of “rug pulls” where developers abandon the project and withdraw funds, leaving investors with worthless tokens.
• Data/oracle risk: DeFi protocols often rely on external data sources or ‘oracles.’ Manipulation or inaccuracies in these data sources can lead to unintended financial outcomes within the protocols.
• Protocol complexity: The complexity of some DeFi protocols can make it difficult for average users to fully understand the mechanisms and associated risks.

Wrapped Tokens

Wrapped crypto-assets (e.g. cbETH, WBTC) (often referred to as ‘wrapped tokens’) are tokenised representations of other crypto-assets. They are typically created to facilitate compatibility and interaction across different blockchain protocols. 

• Smart contract risk: Wrapped tokens rely on smart contracts to ensure their value remains pegged to the underlying asset. These contracts could have vulnerabilities or flaws that can be exploited, potentially leading to a loss of funds.
• Collateral risk: The value of a wrapped token is typically backed by an equivalent amount of the underlying asset. If the mechanisms ensuring this collateralisation fail, the wrapped token’s value might not be preserved.
• Custodial risk: The underlying assets for wrapped tokens may be held in custody by a third party. If this party becomes insolvent, mismanages the assets, or is subjected to fraud or hacking, the value of the wrapped token might be jeopardised.
• Bridging risk: Wrapped tokens are often used to bridge assets between different blockchain ecosystems. The integration layers that facilitate these bridges might suffer from technical issues, hampering the ability to transfer or utilise the tokens as intended.
• Pricing disparity: In certain situations, the price of the wrapped asset and its underlying asset might diverge due to market inefficiencies or liquidity issues.

Meme Coins

‘Meme coins’ (e.g. DOGE, SHIB) are crypto assets whose value is driven primarily by community interest and online trends.  

• Volatility risk: Meme coins can have extreme price volatility, often experiencing rapid and unpredictable price fluctuations within short periods. The value of meme coins can be influenced by social media trends, celebrity endorsements, and other factors unrelated to traditional investment fundamentals.
• Lack of utility: Meme coins often lack intrinsic value or utility, being primarily driven by community interest, online trends, and speculative trading.
• Market manipulation: Meme coins may be susceptible to increased risk of market manipulation including ‘pump-and-dump’ schemes, where the price is artificially inflated followed by a sudden crash.
• Lack of transparency: Meme coins may have limited available information about their development teams, goals, and financials. This lack of transparency can make it challenging to assess the credibility and potential of a meme coin accurately.
• Emotional investing: Meme coins often garner strong emotional reactions from investors, leading to impulsive decisions. Emotional trading activity can amplify losses.

Staked Crypto Assets

Staked crypto assets (e.g. staked ETH, staked ATOM) are locked on the relevant blockchain protocol in order to secure the network and earn rewards.  

• Slashing risk: By electing to stake your assets, you risk potential loss if the network penalises your validator for malfeasance, whether intentional or due to software issues. Some staking service providers will reimburse slashing losses when the validator operator is at fault.
• Liquidity risk: Some protocols require staked assets to be locked in for a period of time, which can prevent you from accessing or selling your assets quickly. 
• APY not guaranteed: The yield or reward rate you get from staking your assets is determined by the relevant protocol and is not guaranteed and may vary over time. 
• Protocol risks:  Staking protocols are often continually evolving. Changes or updates to the consensus mechanism can introduce new vulnerabilities or unforeseen outcomes.