The Biggest Risk in Crypto That Most Investors Completely Ignore
Key Points
Cryptocurrencies rely on centralized layers that are prone to failure.
Investors should take steps to mitigate those counterparty and infrastructure risks.
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Volatility is often considered the biggest risk in investing in cryptocurrencies. Even Bitcoin (CRYPTO: BTC), the world's most valuable cryptocurrency, endured 70%-80% peak-to-trough declines during the crypto crashes in 2017-2018 and 2021-2022. However, many investors often overlook another major risk: the fact that you could suddenly lose access to your own tokens.
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Don't ignore the counterparty risk
Cryptocurrencies are often marketed as "decentralized," but they're actually dependent on layers of centralized platforms, such as exchanges, custodians, lending platforms, and stablecoin issuers. If those platforms fail, you could be locked out of your crypto holdings -- even if the underlying tokens continue trading normally on other exchanges.
That's what happened to investors who put their tokens in FTX, BlockFi, and Celsius Network. These platforms all collapsed because they diverted their customers' funds into other risky investments that ultimately failed. In other words, their customers unwittingly became unsecured creditors in their risky, opaque business ventures.
How can investors avoid that risk?
Coinbase (NASDAQ: COIN) and other major crypto exchanges segregate their customer assets from their corporate assets to avoid repeating those fatal mistakes. However, Coinbase is still vulnerable to hacks and outages, and it admits its crypto investors "could be treated" as general unsecured creditors in the event of a bankruptcy. To avoid those risks, investors should put their coins in hardware wallets, spread their assets across multiple platforms, and avoid high-yield staking products that sound too good to be true.
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Leo Sun has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Bitcoin. The Motley Fool recommends Coinbase Global. The Motley Fool has a disclosure policy.
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