- Cyber Crime and Theft
Hackers and bankruptcies are risks for digital hot wallets, such as Coinbase. One example is the theft of Mt. Gox’s hot wallet private keys in 2016, resulting in the theft of approximately 630,000 Bitcoins from users of Mt. Gox. Currently, the safest way to store cryptocurrencies is on a cold storage hardware wallet – which uses secure chip technology and does not require a user to enter their private key when transacting on a crypto exchange. Trading on a compromised exchange, or computer, becomes safer with this added security layer.
- Assets with a high level of volatility
Cryptocurrencies are highly speculative assets that could double, triple, or even crash to zero without warning. Prices can shift drastically within minutes, causing market dislocations and execution risks. In addition, increased traffic and DoS attacks can cripple exchanges, preventing customers from accessing their funds.
- Regulations by the government
Securities and Exchange Commission, Commodity Futures Trading Commission, Internal Revenue Service, Department of the Treasury, Congress, and state equivalent agencies are considering whether to regulate crypto-companies and exchanges. Regulatory and compliance hurdles are likely to emerge for cryptocurrency companies and institutional investors. The impact of future regulations on cryptocurrency prices is unclear.
- Vulnerabilities in Blockchain Consensus Protocols
Though some argue that blockchain technology is completely secure, as no one has yet broken the encryption and decentralized nature of a blockchain, technical issues may arise if a protocol is found to have vulnerabilities. Some of the attacks targeting Bitcoin’s blockchain have included double spending (the coin is spent in more than one transaction); netsplitting (when two servers become disconnected); mining attacks; and selfish mining pools.
- The lack of disclosure
Companies offering securities have a legal duty to disclose any “material information” regarding the company, its principals, and the investment opportunity that a reasonable person would want to know in order to make an informed decision. As a result of the deregulated market in which crypto companies operate, information asymmetries exist in the market – the company has information that its investors do not. It is more likely that the company will act opportunistically, and against the interests of token holders, the greater the information gap.
- Legal Proceedings, Litigation
In class-action lawsuits, exchanges have been accused of system crashes, lack of access to funds, insufficient “know your client/anti-money laundering” procedures, and breach of fiduciary duty.
- Social Risk
As cryptocurrencies continue to gain traction, there is risk of a market bubble and of unsophisticated investors entering the market without understanding the economic risk.
Initial Coin Offerings (ICOs) are used by companies to raise capital. Due to the lack of registration with the SEC, companies have not always disclosed information investors need to protect themselves. The information asymmetry of ICOs raises questions about possible pyramid schemes and misstatements concerning the value and potential of the Company’s technology and token. Several ICOs have been halted by the SEC, including:
- The REcoin Group Foundation’s REcoin, touted as “the First Cryptocurrency Backed by Real Estate,” has been accused of misrepresenting that it raised between $2 and $4 million from investors when it raised only approximately $300,000.
- PlexCoin was an offering by Plex Corp that falsely promised a 13-fold profit in less than a month.
- Forgot Your Password?
Cryptocurrencies require both a private and public key, or password, to be used. If the private key is lost or destroyed, the user is unable to access the tokens in their digital wallet.