4 Pitfalls to Consider Before Jumping into Crypto

Between the stories we see on the internet, the countless memes, and the growing library of buzzwords, it's hard to research today's economy without running into some references to cryptocurrency. According to the FTC, cryptocurrency is a type of digital currency that exists electronically.¹ You can use crypto like the way you use cash. You can invest in it, use it to buy things, and keep it in your (digital) wallet.

But as with any investment or currency, there are a few pitfalls to consider before jumping headlong into the world of crypto. Here, we outline some of the most significant drawbacks to consider as you research crypto.

Cryptocurrency could be a sound investment for one person and not a good fit for another. To understand whether it's right for you, let's look at four of crypto's pitfalls.

1. Crypto Isn't FDIC-Insured

Another pitfall is that cryptocurrency accounts aren't backed by the government like traditional bank accounts. There are some third-party companies where you can store your digital wallets, but if something happens to those companies, the government has no obligation to step in to help get your money back.

In addition to not being backed by government protection, most cryptocurrency payments don't come with legal protections like credit or debit card purchases do. If you need to dispute a purchase you made using crypto, the process could be long and complicated, if not impossible. In addition, most purchases using crypto aren't reversible. This lack of purchase protection and insurance could be a deal-breaker to some.

2. Crypto May Be Less Secure

Because your currency is stored online, crypto comes with some inherent security risks, both on- and off-line. For example, there's always the risk of cybersecurity breaches, hacking, fraud/market manipulations, and other technological risks.

Just as important, there are also human error risks that one should consider before purchasing crypto. What would happen if you forgot your password or someone stole your laptop? How would you access your digital wallet? The New York Times famously covered the story of Stefan Thomas, a German-born programmer who had two attempts remaining to guess the password to his digital wallet worth $220 million at the time of writing.³ Cryptocurrency and digital wallets give a new meaning and horror to the prompt "Forgot your password?"

3. Crypto Has Major Environmental Impacts

Even though cryptocurrency is digital, mining for crypto has real-world impacts. Mining requires huge amounts of electricity, and while electricity itself is a relatively clean source of energy, the countries with the highest rates of mining burn fossil fuels to generate electricity. According to the Cambridge Bitcoin Electricity Consumption Index, mining for Bitcoin uses more power globally than entire countries, including the Netherlands, the Czech Republic, and Pakistan.⁴ And that's just for Bitcoin, which is a single form of crypto. Mining for Ethereum generates more than 62.9 million tons of carbon dioxide emissions, the same amount as Serbia and Montenegro combined.⁵ According to Digiconomist, a single Bitcoin transaction uses as much power as it takes to run the average US household for over 78 days.⁶

This environmental impact is a major consideration, especially as more investors are moving in the direction of environmental, social, and governance (ESG) investing.

4. Crypto Still Has to Prove Its Case

Lastly, cryptocurrency is still relatively new and needs more time to prove its case. You can buy more things with crypto now than you could in past years, but you can't buy everything with crypto. As with any asset, it's important to remember that we can't see into the future, and we have no idea how it will perform in the coming years. Approach claims about crypto as hesitantly as you would those regarding any other asset.

Cryptocurrency is a major player in today's economy, but it's worth taking time to consider its drawbacks before jumping in.

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LPWM LLC does not provide tax, legal or accounting advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisers.