Bitcoin is like a sketchy roller coaster.
It’s fast and exciting — and your friends say you gotta try it — but you’re also kinda scared of it.
The closer you get, the more you see the shaky foundations. Every time a group of riders rockets past, you see the pillars shake and screws fall out.
But at the same time, you know millions of people have ridden it and had a great time. Some have even said that it changed their life.
You don’t want to miss out.
But you’re still scared! What if it crashes while you’re on it? What if the best decision of someone else’s life becomes the worst decision of yours?
Well, you’re smart to be cautious. Because while there may be fun (and money) to be had on the Bitcoin roller coaster, the risks are very real.
Warren Buffett once told CNBC that, “in terms of cryptocurrencies, generally, I can say with almost certainty that they will come to a bad ending.”
So what’s got Buffet and other traditional investors so spooked? What are the risks that Bitcoin investors don’t like talking about? Are you missing out? Or are you smart to stay off the ride?
Is Bitcoin safe?
Let’s investigate all the risks and safety concerns you should know about before investing in Bitcoin — starting with a clear definition of what “safe” really means.
What’s Ahead:
When it comes to investing, “safe” has two meanings
In the investing world, “safe” usually means “low-risk.”
IRAs, CDs, and mutual funds are considered “safe” investments because you’re almost guaranteed to make money, even if it’s only a trickle (but thanks to compounding interest, a trickle is all you need). Other safe investments may include Blue Chip stocks or a well-priced home with low interest.
But when discussing cryptocurrency, investors often use the term “safe” much more literally. Bitcoin is so new and so radically different that the question “is it safe?” may mean:
- Is my Bitcoin investment figuratively safe, meaning I’ll make a reasonable rate of return?
- Is my Bitcoin investment literally safe from fraud, hacking, theft, etc.?
For most investors, their concerns surrounding Bitcoin trickle into both camps. After all, the potential for a high ROI is rendered pretty moot if your money has a high likelihood of disappearing!
So in this piece, I’ll address both forms of Bitcoin’s “safety.”
And to kick things off, let’s swing back to our old pal Warren Buffet. What’s got him and others so spooked about Bitcoin?
The no. 1 reason traditional investors feel nervous around Bitcoin
Back in March of 2021, Morgan Stanley broke ground as the first big bank to let its wealthier clients invest in Bitcoin.
While this may have sounded like big banks finally stamping their seal of approval on Bitcoin, it wasn’t the ringing endorsement it was made out to be.
For starters, only clients with an “aggressive risk tolerance” were allowed to add crypto to their portfolios. They also must have at least $2 million invested with the firm, and of that, only 2.5% of their net worth could be dedicated to crypto holdings.
Basically, Morgan Stanley told clients, “Fine, you can invest in crypto, but only if you’re ready to lose it.”
Arguably, the bigger story here is that other banks haven’t allowed crypto into client portfolios. Despite the value of BTC exploding from $0.0008 to $64,000 in 10 years, all other investment firms still barred their clients from touching the stuff.
A year later, their stubbornness was vindicated when Bitcoin plunged 71% from its 2021 peak. I bet a ton of people called their financial planners this year to say, “Thanks for not letting me invest in Bitcoin.”
But here’s the thing: investment firms didn’t bar their clients from investing in Bitcoin because they thought it would go down.
Rather, it was because they had no idea where it was going.
And that’s what scared the big banks. It wasn’t jealousy; it was unpredictability.
You cannot build an asymmetric risk profile around cryptocurrency
Have you ever wondered why despite the ups and downs of the stock market, your retirement account consistently provides 7% returns each year?
The reason retirement accounts (almost) always make money is because they’re built upon what’s known as an asymmetric risk profile. Basically, whoever’s managing the investments in the portfolio for you has built a “house always wins” scenario.
“You want to have the odds really, really in your favor to win over the long-term. That requires you to collect as much info as possible” says Varun Marneni, an advisor with Atlanta’s CPC Advisors and Raymond James Financial Services.
Investment firms perform a staggering amount of due diligence when investing money, whether it’s their clients’ or their own. Data analytics, complex algorithms, and good old-fashioned research all come into play when designing an asymmetric risk profile.
Now, here’s what has them spooked about Bitcoin.
With more traditional investments, there’s a ton of info out there that investors can use to essentially “predict the future” and handpick the best investments. That’s why good investing is based on skill and less on luck. Data reduces risk.
But Bitcoin has no data to chew on.
“It’s 100% speculation,” says David Hunter, CFA. As Director of Research and Investments for CPC Advisors and Raymond James Financial Services, a big part of David’s job is to explore ways to predict the future performance of Bitcoin. But because BTC is based on demand only, its future value is as unpredictable as a rare Beanie Baby or a baseball card. It could be worth millions or simply worthless.
With that in mind, let’s jump back to Safety Test No. 1: Is my Bitcoin investment figuratively safe, meaning I’ll make a reasonable rate of return?
Source: Giphy.com
Bitcoin pretty much flops Safety Test No. 1 because there’s no firm data supporting the idea that it’ll go up. No P/L sheets, no earnings reports, no pending patents — nada. Nobody thought it would crash 71% in 2022, and here we are.
But hey, maybe you’re still willing to roll the dice. If you buy Bitcoin and hold it, what are the chances your investment will — for lack of a better term — survive?
To find out, let’s move on to Safety Test No. 2: Is my Bitcoin investment literally safe from fraud, hacking, theft, etc.?
And answering that is a five-part response…
The 5 biggest risks to your Bitcoin investment
Many folks view Bitcoin as a “risk-adjusted” investment, meaning the gains justify the risk it adds to your investment portfolio.
After all, if you bought into Bitcoin at $1,000 and it’s now at $20,000, that’s still 1,900% ROI. Those kinda gains more than make up for the risk.
But that was from 2012 to 2022. Today, Bitcoin faces more existential threats than ever before.
So what are they, and how likely are they to wipe out your Bitcoin investment overnight?
1. Bitcoin deposits are not FDIC-insured
Did you know that the FDIC automatically insures your money from theft and hacking? Coverage goes up to $250,000 per account and includes your:
- Checking
- Savings
- Money market deposit accounts (MMDAs)
- Certificates of deposit (CDs)
So if the bank gets hacked and your account gets emptied, the government will refund your money.
Your Bitcoin holdings, however, are not insured.
So if your crypto gets hacked, well, sayonara. Mt. Gox was hacked in 2014 and the vast majority of victims still haven’t seen a single Bitcoin returned.
Speaking of hacks…
2. The blockchain can’t be hacked, but exchanges can
Satoshi Nakamoto’s original design for blockchain is equal parts simple and genius. The blockchain, the virtual ledger that stores all Bitcoin transactions and regulates its value, needed to:
- Be safe from outside threats
- Have a built-in incentive for dedicating CPU power
- Allow only a trickle of bitcoin to control inflation
Nakamoto achieved all three objectives by surrounding the blockchain in a protective tornado of computer code. Anyone powerful enough to breach it might as well join it, since they’d be rewarded for “mining” with free bitcoins. Plus, the number of miners would regulate new coins, controlling inflation.
Twelve years after v0.1 of Bitcoin and blockchain was released on SourceForge, it remains pretty impenetrable. Countless miners have joined it and nobody has destroyed it.
However, to use an apt analogy, a “chain” is only as strong as its weakest link — and although the blockchain has remained safe, the exchanges get targeted all the time.
Since the early 2010s, there have been dozens of “Bitcoin heists” where bad players sneak into exchanges and make off with millions in crypto. Here are just a few of the more high-profile ones, with their USD equivalent at the time of the heist:
- Coincheck, January 2018: $532 million
- Mt. Gox, February 2014: $470 million
- BitGrail, February 2018: $170 million
- Bitfinex, August 2016: $72 million
- Upbit, November 2019: $50.7 million
- Binance, October 2022: $570 million
Unlike a traditional bank heist, crypto heists lead to a cascade of further issues for investors, like:
- A drop in crypto values, like Bitcoin losing 50% after the Mt. Gox hack
- The folding of the exchange, like Coincheck, reducing avenues of investment and causing lost wallets
- Increased government scrutiny and regulation
In total, over $3.2 billion was stolen by hackers in 2021 alone. And 2022 isn’t shaping up to be much better, with $1.2 billion stolen in Q1 alone.
Crypto heists are a huge mess — and even if your chosen exchange builds their cyberdefense walls nice and tall, you yourself may still be targeted.
3. Someone could steal your passcode (or you could simply forget it)
If someone steals your credit card and rings up $3,000 at the nearest Coach outlet, you can simply call Chase and reverse the charges.
But what if someone steals your crypto?
“We get inquiries from people who had their bitcoins or cryptocurrency stolen… on a daily basis,” writes Paul Sibenik with cybersecurity firm CipherBlade. “A considerable amount of the time, these individuals think or believed they had an ‘extremely secure setup’ and seek to place blame on other parties.”
But unfortunately, there’s not much you can do if your crypto is stolen. That’s due to a subtle, but critical difference in how crypto exchanges and banks view security.
When a hacker breaches your bank account, the bank sees it as their fault and compensates you immediately. In the aforementioned example, that even extends to circumstances where you leave your credit card on the ground.
But crypto exchanges don’t protect your account like this — rather, they give you the tools to protect it yourself, so if someone breaches your account, it’s your fault rather than theirs. Coin exchanges only protect you from site-wide hacks, and even then, their best efforts may not restore your account to its previous balance à la Mt. Gox.
Sometimes, the security pendulum swings too far in the other direction. In January 2021, The New York Times did a piece on how lost passwords were locking investors out of their Bitcoin fortunes. Some investors have taken so many security measures that they’ve locked themselves out of their own bitcoins safe — and Bitcoin wallets generally have no “Forgot Password?” feature.
There may only be a small sweet spot between locking hackers out and locking yourself out of your crypto wallet. Over time the sweet spot may not exist as hackers find more sophisticated ways to conduct personal wallet theft on a massive scale.
4. Bitcoin is already sucking up more energy than Australia
Over 190 countries have signed the Paris Agreement, coming together to combat the effects of climate change. And now that Bitcoin has proven worse for the environment than meat production and oil drilling, it’s likely that many of those countries will consider a ban. Heck, Bitcoin has even started causing rolling blackouts in several Paris Agreement-signing countries like Canada and Iran.
Sure, Twitter founder Jack Dorsey says the future of Bitcoin mining is in green energy like solar and hydroelectricity. But why, during a global energy crisis, should the world devote green energy development to Bitcoin? And considering that each Bitcoin transaction consumes more electricity than the average U.S. household does in six weeks, we’re going to need a lot of solar panels to keep Bitcoin going.
Needless to say, the governments of the world haven’t been so enthusiastic. Rather than embrace it, many are considering a ban (if they haven’t banned it already).
5. More countries could ban Bitcoin over time
The list of countries that have banned Bitcoin is growing.
Two of the world’s largest economic superpowers — China and India — have effectively criminalized it.
Bolivia and other South American countries have deemed all crypto activity illegal, as have North African nations Algeria, Egypt, and Morocco.
The list of countries that approve of Bitcoin is small. Denmark, the United States, and the United Kingdom have all given it the go-ahead. Germany’s considering it.
Most other countries fall somewhere in the middle. The governments of Colombia, Ecuador, Canada, Saudi Arabia, Jordan, Qatar, Iran, Bangladesh, Taiwan, Cambodia, Vietnam, and more have made cryptocurrency illegal in some capacity, telling banks and businesses to stay away and banning it as a form of currency.
Many in the crypto community say that world governments will lift trading bans just as soon as they figure out how to tax it. But that day may never come; the IRS declared Bitcoin taxable in 2014 and in the following years, less than 0.08% of crypto traders paid taxes.
It eventually took the IRS seven years to develop a system for tracking down crypto tax dodgers using blockchain analytics. But these crypto tax tools are undoubtedly extremely expensive and out of reach to most nations. And if they can’t tax it, governments are never going to let Bitcoin into their economies willingly. No country would knowingly create a playground for fraud and tax evasion.
Even if we zoom out a bit, there’s very little reason for any country to accept Bitcoin. Even if they can effectively tax it, Bitcoin is still a resource hog, an economic liability, and it distracts investors from investments that stimulate national economic growth, like stocks and bonds.
Sure, they could consider adopting it as an official, second currency — but El Salvador already tried that, and the results were catastrophic.
Needless to say, national bans are bad for Bitcoin. They’re bad for prices (Bitcoin plunged 30% after the China ban), but they’re also bad for the safety of your long-term investment. Every country that refuses to regulate crypto can become a breeding ground for hackers, fraudsters, and scam artists. Just look at Satoshi Island in the tiny island nation of Vanuatu.
Anyways, let’s circle back to Safety Test No. 2: Is my Bitcoin investment literally safe from fraud, hacking, theft, etc.?
Source: Giphy.com
Sadly, Bitcoin investments are still proving vulnerable to fraud, scams, hacking, theft, and even the threat of your country banning it. If you live inside a country where Bitcoin has at least been approved (USA, Norway, etc.) your best bet for keeping a long-term investment safe is to store it in an offline cold wallet.
Just don’t lose it!
The bottom line
Like a rickety roller coaster, Bitcoin is fast, exciting, and thrilling even just to spectate. But don’t let FOMO or peer pressure lure you into a false sense of security.
If you’re feeling nervous about a Bitcoin investment, your feelings are 100% valid. The Bitcoin roller coaster is both literally and figuratively unsafe. It always has been, but with so many screws loose, 2022 or 2023 may be the year the rickety contraption finally collapses.
I’m not saying you should or shouldn’t invest in it; just that the risks are higher than ever. But if you’re still intrigued, check out our beginner’s guide to investing in cryptocurrency.
Read more:
About the author
