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As with buying and trading commodities and fiat (government-issued) currencies, purchasing Bitcoin—a type of cryptocurrency—isn't free of risk. Bitcoin's volatile price may make it riskier than stocks and other types of investments, but that volatility can potentially make it more profitable too. Additionally, Bitcoin's nature as an emerging technology, and the knowledge required to securely purchase and store your Bitcoin, may add to the risk involved.
The early days of Bitcoin may have been marred by hacks and fraud, but with the technology becoming more regulated and accepted by global financial institutions, it has largely come out of the shadows and gained a degree of legitimacy. As the technology has gained wider acceptance in recent years, new ways to buy, sell and store Bitcoin have made it a simpler, more convenient and more secure investment method.
If the allure of Bitcoin is tempered by concerns about security or investment risk, read on to learn more.
What Are the Risks Associated With Bitcoin?
There are three primary risks associated with buying and owning bitcoins.
- Bitcoin's value may decrease after you buy your bitcoins.
- Someone could get access to your private key and take your bitcoins.
- You could lose your private key that allows you to access your bitcoins.
The first risk is the same risk that's associated with making any type of investment. Whether you're buying stocks, bonds, mutual funds, indexes or lending money, there's a chance that the value of your investment will decrease or the other party won't pay you back. You may even lose your entire investment.
Bitcoin is a particularly volatile investment, meaning the price may quickly move up or down. If you buy Bitcoin and later sell it when its value is higher, you could stand to gain a lot of money. Over the course of the 2020 calendar year, Bitcoin saw a low value of around $3,800 and closed out the year nearing the $30,000 mark, which clearly presents an opportunity for profit to savvy investors. In recent years, however, people have made large Bitcoin investments only to watch the price drop from nearly $20,000 U.S. dollars per bitcoin to less than $3,500 USD per bitcoin over a relatively short time—over an 80% drop. If you plan on getting into Bitcoin now, you may want to keep this in mind.
The other risks are associated with your private key. Technically, you'll never physically possess bitcoins—Bitcoin is a digital currency after all. However, a private key is what gives you the ability to spend or transfer bitcoins, which gives you ownership over the bitcoins associated with it.
If someone gets your private key, they could transfer the bitcoins into their digital wallet, and you might not have any way to get your money back.
Some people choose to store their private key on their own rather than using an online wallet. They may do this by writing it down or keeping it on a storage device (like a thumb drive). It's a safe option, particularly if your storage device isn't connected to the internet. However, it opens up the possibility of losing your private key—and there are horror stories of people losing tens of millions of dollars worth of bitcoin after losing or throwing out storage devices.
How to Keep Your Bitcoins Safe
The best way to keep your bitcoins safe is to have your private key stored in a device or app that isn't connected to the internet, or in a non-digital form, such as written on a notepad. When your private key is stored somewhere that isn't connected to the internet, it's called a cold wallet.
Physical cold wallets can be kept in fireproof safes or other secure locations. A safe deposit box at a bank could be another option, although those aren't necessarily sure-proof as items could still be lost or damaged. You could also add an additional layer of protection to your cold wallet by encrypting the device. Or, in the case of a written private key, altering a few digits so it won't be usable by others (for example, by changing the first number from a 5 to a 9 and committing that to memory or leaving yourself a hint to the change).
Some people prefer to keep their bitcoins in an online digital wallet, particularly if they frequently buy and sell the currency or want easy access to their digital wallet from different devices. Many online cryptocurrency platforms or exchanges will create a wallet for you when you open an account.
Some platforms will also keep much of the bitcoins in their system in cold (offline) storage, and only have a small percentage in hot (internet connected) storage for users. Similar to how a local bank branch doesn't have enough cash to cover all its customers' deposits in its vault. As a result, a hack won't necessarily put bitcoins belonging to all their users at risk.
Beyond where you store your wallet, the largest risk factor may be the human element. Cryptocurrency scams are on the rise, and fraudsters may try to get you to share your private key or account details. Or get you to install software that infects your devices and can steal this information.
Additional Things to Know Before Buying Bitcoin
There are a few more things you should know if you're interested in buying Bitcoin:
- Bitcoin isn't the only cryptocurrency. Bitcoin was the first major cryptocurrency, and it remains the best known, but you can buy and sell many cryptocurrencies like it. These won't necessarily be more or less safe than Bitcoin, and may be more or less profitable.
- Bitcoin trading accounts might not be insured. The Securities Investor Protection Corporation (SIPC) insures many brokerage accounts. The SIPC insurance offers up to $500,000 (which includes $250,000 from cash holdings) to customers, protecting them if the company goes under. However, SIPC insurance doesn't cover commodities or currencies, including Bitcoin.
- Diversifying your investments can limit risk. Putting the majority of your savings into a single investment opens you up to taking a major loss if the investment's value drops. With a volatile investment like Bitcoin, that may be more risk than you want to take on. Investing small amounts among different types of investments, or diversifying your investments, can help you limit your risk.
Alternatives Ways to Invest
If you're just starting to invest and unsure about your options, be sure to spend time educating yourself before making any major decisions. There are many investment options available and Bitcoin, and cryptocurrencies in general, are relatively new. More traditional investments include:
- Stocks: Purchasing a stock makes you a partial owner of a company. The value of the stock may rise and fall depending on how well the company is expected to do in the future, which means your investment can grow as the company expands. Additionally, some companies pay dividends to shareholders, giving you a share of their profits.
- Bonds: A bond is a loan that's given to a corporation or government. As the lender, you can receive interest payments over time and then get back the principal loan amount at the end of the bond's term.
- Mutual funds and exchange-traded funds (ETFs): Mutual funds and ETFs allow you to quickly invest in a wide range of stocks, bonds or a combination of the two. They do this by being made up of or mirroring a group of other investments. For example, you can invest in the 500 largest companies in the U.S. stock market by buying shares of an S&P 500 mutual fund.
How to Monitor Your Credit and Prevent Identity Theft
Losing your bitcoin is only one of many potential negative consequences of falling victim to identity theft. While acting cautiously and avoiding theft is ideal, having systems in place to quickly detect potential identity theft may help you respond before too much damage is done.
Experian offers free credit monitoring with real-time alerts, which could help if someone uses your personal information to try and open a credit account. The subscription-based Experian identity theft and credit protection service go a step further with dark web monitoring. If your information is found online, you can take extra steps to secure your accounts, such as changing passwords or moving your private key to a cold wallet.