Bitcoin Remains a Dangerous Wager Even When Its Price Rallies

    A lack of regulation and price volatility are just two of many risks

    Illustration of stock market charts and a digital hand with digital currency Illustration: Lacey Browne/Consumer Reports, Getty Images

    Don’t be too fast to invest in bitcoin and other digital currencies when you see prices shooting up. The cryptocurrency market remains as volatile as ever—as of today, bitcoin’s price is down more than 50 percent in 2022—and fraud and security are a big concern.

    Just look at what happened to bitcoin, which has shed about two-thirds of its value since its peak of $67,000 per coin in November 2021. And there are still many factors that could push cryptocurrencies even lower. So investors should proceed with extreme caution. 

    “People are desperate for anything that can bring them instant wealth, but [cryptocurrencies] are very risky investments because the technology is new and unproven,” says Jerry Brito, executive director of Coin Center, a nonprofit research and advocacy group in Washington, D.C., that’s focused on the public policy issues facing the cryptocurrency industry. “You shouldn’t invest in stuff you don’t understand, and you shouldn’t be investing money that you can’t afford to lose.”

    Crypto-Confusion Persists

    While admitting you’re confused about crypto may leave you feeling like a Luddite, it’s understandable—and you’re not alone.

    More On Crypto, Banking & Investing

    Americans have a high degree of uncertainty about crypto. Only 20 percent have ever owned it, according to a nationally representative survey (PDF) of 3,208 adults conducted by Consumer Reports in June and July 2022. About a quarter of Americans say they don’t know whether any of their friends or family own crypto. When asked if they would ever use cryptocurrency in different ways, many people are not sure. That includes the 25 percent who don’t know if they’d use a bank that offers crypto options, and the 22 percent who aren’t sure if they’d use it for a major purchase like a home or a car. Over a quarter (26 percent) are unsure if crypto firms should be regulated in the same way as other financial institutions.

    Despite the public’s seeming desire for more clarity, financial regulators are still figuring out things about cryptocurrencies. Are they securities like stocks and bonds or are they commodities like gold and oil? Should they continue trading on unregulated non-bank exchanges (famous for their Super Bowl ads featuring stars—like the comedian Larry David—who say you don’t really need to understand crypto in order to invest in it) or should crypto trading happen on highly regulated bank platforms that are mostly shut out of the market? 

    In September the Biden administration released a fact sheet outlining a number of recommendations gleaned from numerous studies it commissioned to investigate how government regulators should approach the “responsible development of digital assets,” including cryptocurrency.

    Regulators like the Securities and Exchange Commission (SEC) and Commodity Futures Trading Commission (CFTC) are now being encouraged “to aggressively pursue investigations and enforcement actions against unlawful practices in the digital assets space.” Also, the Consumer Financial Protection Bureau (CFPB) and Federal Trade Commission (FTC) are being pushed to “redouble their efforts to monitor consumer complaints and to enforce against unfair, deceptive, or abusive practices.” 

    Plus, regulatory agencies are being encouraged to issue guidance and rules to address risks in the digital asset ecosystem. And law enforcement agencies are being urged to work together to address “acute risks facing consumers, investors, and businesses.”  

    The administration also said the Financial Literacy Education Commission (FLEC) will lead public awareness efforts “to help consumers understand the risks involved with digital assets, identify common fraudulent practices, and learn how to report misconduct.”

    When it comes to how the financial system and banks can participate in the digital asset market, the administration said that in October, the Financial Stability Oversight Council (FSOC) will publish a report discussing digital assets’ “financial-stability risks, identifying related regulatory gaps, and making additional recommendations to foster financial stability.” 

    A number of other concerns were addressed, including fighting illicit finance, reinforcing global financial leadership and competitiveness in the U.S., and advancing responsible innovation, which includes an initiative by the National Science Foundation (NSF) to back research “to ensure that digital asset ecosystems are designed to be usable, inclusive, equitable, and accessible by all.” 

    Of course, the SEC and other government regulators have been aware of the dangers the current uncertain climate can present to the millions of retail investors who have billions of dollars tied up in the market—or who may be considering putting their money into it. 

    In April the SEC’s chairman, Gary Gensler, said his agency and the CFTC were examining crypto regulatory issues. (The SEC regulates securities like stocks and bonds, and the CFTC regulates commodities like oil and gold.) 

    “I’ve asked staff to consider how best to register and regulate platforms where the trading of securities and non-securities are intertwined,” he said. “In particular, I’ve asked staff to work with the CFTC on how we jointly might address such platforms that might trade both crypto-based security tokens and some commodity tokens, using our respective authorities.”

    In early September the SEC announced plans to add an Office of Crypto Assets and an Office of Industrial Applications and Services to the Division of Corporation Finance’s Disclosure Review Program (DRP). These two offices will help focus the agency’s efforts in areas of the financial sector that have seen tremendous growth.

    The Office of Crypto Assets will review filings involving crypto assets and the Office of Industrial Applications and Services will be responsible for the non-pharma, non-biotech, and non-medicinal products companies that are currently assigned to the Office of Life Sciences. The new offices should be established later this fall, according to the SEC’s announcement.

    “As a result of recent growth in the crypto asset and the life sciences industries, we saw a need to provide greater and more specialized support in the DRP’s Office of Finance and its Office of Life Sciences,” said Renee Jones, director of the Division of Corporation Finance, in a press announcement. “The creation of these new offices will enable the DRP to enhance its focus in the areas of crypto assets, financial institutions, life sciences, and industrial applications and services, and facilitate our ability to meet our mission.”

    Banks are eagerly awaiting more clarity from regulators and say they wish the authorities would hurry up in making rules to govern how they might be able to participate in the market. In August the American Banking Association sent a letter to the Biden administration requesting that it step up efforts to clarify regulations. It says banks are a safer alternative for people looking to invest in crypto because they’re highly regulated. But without clearer rules on how to join in, the bank group says its members can’t offer their services effectively. 

    “The combination of these two approaches—inaction on the one hand to bring into the regulatory perimeter non-bank crypto companies, and limitation on the other of banks’ ability to engage responsibly in the digital asset market—creates an environment that makes it nearly impossible for responsible financial innovation to occur in this space, causing it to remain in the Wild West,” wrote Brooke Ybarra, head of the American Bankers Association’s office of innovation.

    But as banks seek ways to enter the crypto investing market more robustly, senators including Elizabeth Warren and Bernie Sanders have called on the Office of the Comptroller of the Currency to walk back rules issued during the Trump administration that had given them some ability to participate. The senators say they’re concerned that the rules “may have exposed the banking system to unnecessary risk,” citing the recent meltdown.

    Acting Comptroller of the Currency, Michael Hsu, defended the regulator’s moves. “I think we’re doing a pretty good job,” he said on Bloomberg. “See Exhibit A: A whole bunch of stuff just happened, and the banking system is in pretty good shape, knock on wood. I think part of that is the actions we’ve taken.”

    But until regulators issue clearer rules, crypto is likely to continue to be extremely volatile and risky. And even when regulators do, they’ll undoubtedly have a big impact on the price of digital currencies.

    Here are four more reasons to be cautious about investing in cryptocurrency.

    Fraud and Security Concerns

    The most popular way to buy and sell cryptocurrencies is through an exchange where buyers and sellers come together online to trade.

    But some exchanges are fake, luring unsuspecting investors to open an account. When they make a purchase, the criminals steal the money and the investor never receives the cryptocurrency.

    Even legitimate exchanges can be dangerous because many of them may not have adequate security in place. Prominent exchanges have been robbed by hacker groups of billions of dollars’ worth of cryptocurrency. Consumers reported losing over $1 billion to fraud involving cryptocurrencies just from January 2021 through March 2022, according to an analysis from the Federal Trade Commission. The biggest hack in history occurred in August of 2021, in which an exchange named Poly Network lost $610 million, according to Coin Central. More recently, an exchange known as Wormhole lost $32 million to hackers. In such cases there’s very little authorities can do to recover the funds.

    Matt Mitchell, a tech security researcher, says that while lax security is a big risk, there are some exchanges that have invested in technology to lock down their systems. Among them, he says, are CoinDesk, GDax, and Kraken.

    Initial Coin Offerings Provide Few Protections

    For some people, one attraction of cryptocurrencies is the ability to participate in an initial coin offering, or ICO. Investors jump in, hoping to get the digital currency at a low price and then profit as it rises.

    But ICOs are far riskier than stock IPOs—and have other key differences.

    For one thing, in an IPO, the average investor can’t easily participate. Companies going public award their shares to institutional investors, which may then make them available to their customers as long as their income meets certain thresholds. In this way, average investors can’t take undue risks that could wipe them out.

    That’s not so with ICOs—anyone can participate. The result is that some overeager investors may take on too much financial risk.

    Another difference: ICOs don’t have to live up to the same high standards as IPOs. Before a company can file to go public, it has to show a minimum earnings level, undergo audits, issue a prospectus that explains the company’s financials, etc. In other words, by the time shares are offered to the public there has been some due diligence, the shares are considered viable, and investors have access to information.

    No such safeguards exist for ICOs. Cryptocurrency issuers might not even have a track record that investors can examine to see whether the company is financially sound. While many do publish a white paper explaining why they’re raising funds, there’s no legal requirement that they do so.

    In the past, the SEC has warned investors that it might not effectively pursue bad actors or recover funds for investors, partly because these markets often operate outside the U.S.

    There Will Be Fees

    It’s true that when bitcoin was created, the idea was partly to create a bank alternative as a way to avoid high fees, Mitchell says. But trading cryptocurrencies will still cost you, usually a fraction of a percent of the total transaction amount, depending on the exchange.

    You can avoid exchanges and buy and sell bitcoin through, say, a cryptocurrency wallet—an app you load on your smartphone. The fee you’re charged will depend on the total number of people globally who are buying and selling that currency. The more people trading, the higher the fee, Brito says.

    Years ago, before most people were thinking about trading bitcoin, a wallet transaction fee was puny. In 2019 it averaged around 6 cents, according to Bitinfocharts, a fee tracker. That rose to around $65 per transaction when crypto mania sent prices (and orders) soaring in 2021. As bitcoin’s price crashed back down to earth, transaction fees also fell. They were hovering around $1.70 as of early August, according to Bitinfocharts.

    Cryptocurrencies Are Easy to Lose

    When you buy a cryptocurrency and place it in your smartphone’s cryptocurrency wallet, if you don’t back up the app and you lose your phone, you’re out of luck. If you misplace or accidentally delete your “key”—a long password that’s generated when you open your account—there’s no “forgot my password” option to help you.

    Mitchell says that phone operating systems could also become corrupted, which might delete a wallet from a user’s phone. That’s why there’s new hardware now available for people to back up and secure their wallets.

    Editors Note: This article has been updated with more details about Consumer Reports’ cryptocurrency survey responses.

    Image of Octavio Blanco, editor at CR with Money CIA

    Octavio Blanco

    My mission: To write stories that broaden readers' horizons and offer new solutions they can apply to their lives. Who I write for: My family, my friends, my neighbors, myself, and—most important—you. My passions: Music, art, coffee, cheese, good TV, and riding my electric bike (for now). Find me on Twitter: @octavionyc