Decoding the risks of digital assets
11 March 2024
Digital assets have boomed in popularity over the past decade, with revenue in the market projected to reach over $80 million in 2024. But as these assets grow, so do the risks associated with their unpredictable nature.
In this blog, we break down just a few of the risks faced when dealing with digital assets.
An unpredictable market
Like stocks and shares, digital assets are tradeable, and the price at which they trade depends on the market. However, digital assets – cryptocurrencies in particular – tend to have much higher levels of volatility than other assets – with the value changing rapidly and unpredictably within days, or hours.
And unlike traditional currencies, cryptocurrencies aren’t backed by any physical assets or governmental authority, and are not supported by anything tangible like gold, while purchasing digital assets doesn't grant ownership in a company, or of part of it – just the asset.
It’s also worth noting that the relatively new nature of cryptocurrencies and the limited number of people trading them means that large transactions can swing prices on a regular basis – something that can result in substantial gains or losses for those who are trading them.
Low liquidity
Digital assets, particularly those with limited market capitalisation, often face challenges related to liquidity when compared to traditional assets. The prices displayed for digital assets are usually based on information from exchanges, but with the absence of a centralised marketplace, the prices can be extremely varied.
Illiquidity can cause several issues: sudden fluctuations in price, substantial disparity between the purchase and sale prices, and trades not going through. And in some situations, where there aren’t enough people wanting to buy the asset, it may even be almost impossible for someone to sell what they have.
Cybersecurity risks
Digital assets aren’t tangible – they operate entirely in a virtual space and rely on blockchain technology and online platforms. This makes them extremely susceptible to cyberattacks, while the decentralised and pseudonymous nature of digital assets only amplifies this vulnerability.
Hackers will often target digital asset exchanges and wallets to exploit vulnerabilities and gain unauthorised access to the funds. Once inside, they can manipulate transactions, compromise private keys, and drain funds.
Security breaches such as phishing, ransomware attacks and malware can lead to huge financial losses and while there are some ways these risks can be mitigated, there is still no guarantee the assets will stay safe.
Uncertain regulatory landscape
The nature of digital assets makes them challenging to regulate. While there has been some movement on cryptocurrency regulation in the UK, governments and regulatory bodies worldwide are still grappling with how to categorise and oversee these assets, meaning that the rules vary significantly from one jurisdiction to another.
Traditional assets have regulatory frameworks in place to safeguard investors and to ensure fair practices across the market. And in the event of disputes or malpractices, there are clear regulations in place to allows consumers to take legal action.
Digital assets lack this safety net and integrity, increasing the risk of fraud, scams, and market manipulations by bad actors that can lead to financial losses.
The risk of fraud and manipulation
As an emerging and unregulated asset class, digital assets are vulnerable to fraud. These fraudulent activities can range from fake projects enticing investors with promises of high returns, to “scams on scams” where fraudsters target existing victims with promises to get their losses back but instead take more money from them.
Social media has also driven up so-called “pump-and-dumps” where large amounts of an altcoin are bought, aggressively promoted it to inflate the price, and then sold.
And because digital assets are often nameless and faceless, it can be almost impossible to trace and recover stolen funds. Until a robust regulatory framework is in place, fraudsters and bad actors will continue to exploit these vulnerabilities, putting digital assets – and those who own them – at risk.
For more information on digital assets, download our free guide.
R3 members can provide advice on a range of business and personal finance issues. To find an R3 member who can help you, click below.