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Risks of trading cryptocurrencies

Cryptocurrencies trading is now becoming more and more popular in the Philippines.

For example, according to Nichel Gaba, CEO and founder of Philippine Digital Asset Exchange, the local exchange saw a 70-fold increase in transactions and a 15-fold increase in customers in less than a year.

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The growing popularity of cryptocurrencies trading is not surprising given the sharp increase in prices of digital currencies like Bitcoin, Ether and Dogecoin in the past few months, making them very attractive to anyone who wants to make money quickly, especially during these difficult times.

However, it is important to note that the rewards of trading cryptocurrencies also come with significant risks that could lead to huge losses.

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Cold wallet

Cryptocurrency exchanges where traders buy and sell digital currencies could go out of business. They could also get hacked. Even Binance, one of the world’s largest digital currency exchanges was hacked in 2019. If you keep the cryptocurrencies you bought in an exchange’s platform and it goes out of business or gets hacked, your digital currencies could be gone for good. One way to prevent your cryptocurrencies from being stolen is to store them in a cold wallet or a special device that is designated to physically store cryptocurrencies.

However, the risk of storing your digital currencies in a cold wallet is losing your private key. If this happens, you will not be able to access your cryptocurrency.

You also need to do your homework when buying cryptocurrencies. There are thousands of cryptocurrencies to choose from and at some point, many of them will disappear and become worthless.

Unlike stocks or bonds which are securities that can be valued based on their projected future cash flows, or fiat currencies like the peso or the dollar that go up and down based on a country’s economic fundamentals, the value of cryptocurrencies is largely dependent on demand and supply coming from all types of investors including traders who have very short investment time horizon.

As such, nobody knows what the real value of a cryptocurrency is, making prices very volatile.

Although prices of cryptocurrencies increased several folds the past few months, their prices can also go down sharply like what happened last week.

Uncertainties

When this happens, the ability to sell right away is very difficult because there is usually a stampede of traders who also want to exit their positions.

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Moreover, the surge in trading volume can cause even the biggest exchanges such as Coinbase and Binance to suffer from outages, adding to the challenges of selling cryptocurrencies that are falling in price.

Finally, it is not yet clear whether cryptocurrencies will achieve wide-scale adoption. Although cryptocurrencies were created after the global financial crisis as a way for people to control their money themselves, without having to rely on banks or governments, cryptocurrencies are not yet accepted as legal tender to buy physical goods.

Central banks can also tighten regulations on cryptocurrencies. For example, aside from not recognizing cryptocurrencies as legal tender, Chinese regulators recently tightened restrictions on cryptocurrencies, banning financial institutions and payment companies from providing services related to digital currencies.

For the said reason, it remains uncertain whether cryptocurrencies will make good long-term investments.

In summary, although trading cryptocurrencies can be profitable, it can also be very risky. Make sure that you are aware of these risks and look for ways to manage them before you start buying cryptocurrencies. INQ

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