Protecting Crypto: 6 Factors Contributing to Investor Loss

Authored by Francisco Moran and Casper Xiao

Cryptocurrency has been a topic of hot debate since its debut in the wake of the 2008 Global Financial Crisis. Despite initial excitement and hype surrounding it, the crypto market has since been marked by extreme volatility and a lack of clear oversight and regulation, leaving consumers vulnerable to misinformation and significant losses through scams, hacks and “pump and dump” schemes. The value of Bitcoin, the leading cryptocurrency, has fluctuated greatly over the years, starting at USD$0.0008 in July 2010, reaching a peak of USD$65,000 in February 2021, before falling to around USD$17,400 as of 2023. Similarly, Ethereum, the second largest cryptocurrency by market capitalization, began at a value of USD$0.311 per coin in 2015, reached a high of USD$4,815 in November 2021 and dropped significantly to around USD$1,330 as of early 2023.

What makes consumers so vulnerable to crypto investments over stocks? Biztech Lawyers examines 6 key factors that contribute to investor loss.  

Please also see our Tech Lawyer’s Guide to Global Cryptocurrency Regulation in 2023 (AU, UK, US) for a deep dive into the current state of laws and regulations in curbing the above issues.

1. Crypto Market Volatility

Cryptocurrency markets are very unpredictable and the prices can fluctuate rapidly. This can lead to big losses for investors who aren’t prepared for the risk, especially if they have leveraged positions. Stock markets on the other hand, are less volatile as the price changes are more gradual. The VIX Index (also known as CBOE volatility index), which is a popular measure of the volatility of stock markets deriving from S&P500 option prices has historically had an average of around 20. In significant contrast, the volatility of crypto assets is much more dynamic, with daily changes in excess of 20-30% and a similar measure of volatility for cryptocurrencies known as the Crypto Volatility Index has reached tenfold the figure of the VIX index and sometimes even more.

2. Hype

Encouraged by media and social media promotion, hype can lead many investors, especially novices and those who want to make a quick buck, to invest in cryptocurrency without understanding the risks involved, resulting in significant financial losses. One of numerous examples of crypto products that surged on the hype and took advantage of novice consumers, was the concept of “yield farming”, where numerous schemes promised unrealistic returns or kept their true risks hidden or were outright scams. Examples are a stablecoin which offered an annual return of 20% interest rate (TerraUSD), tokens which offered a compounding annual percentage yield of absurd amounts such as 30,000% of the token’s initial value (Time, Klima, PanCake Swap, etc) and numerous other schemes that turned out to be complete scams, such as the Squid Game Coin, which built up on the hype of the Netflix show of the same name. where the value went up meteorically. $3.36 million was initial invested into it by unsuspecting investors, and then 15 minutes later, it was all gone and the value of the ‘coins’ plummeted down to next to nothing, leaving investors penniless.

3. FOMO

The fear of missing out is a significant contributing factor to investor loss in cryptocurrency. As hype drives more novice investors to put their money in, the price starts to rise and more and more investors rush in, driven by FOMO, fueling the upward trend, and creating a self-fulfilling cycle of buying and selling, creating a price bubble, until the bubble pops and a significant price crash occur. This can create significant losses for many investors who entered the market at the peak of the hype, as they see it as doing well and don’t want to miss out on the profit.

4. Celebrity Endorsements and Promotions

Celebrities and social media influencers are also a large contributing factor to the hype and FOMO in the crypto markets through marketing tactics, which could be seen as reckless or misleading and deceptive. Some celebrities are now embroiled in lawsuits or endorsing specific coins or crypto exchanges without fully disclosing the financial compensation they have received for promoting them, or where they have spoken highly of certain coins without conducting proper due diligence.

Examples include Kim Kardashian, who promoted a cryptocurrency called EthereumMax on her instagram in 2021, which turned out to be a “pump and dump” scheme which plummeted 97% after lots of consumer investors flocked to it. Furthermore,  NBA superstar Shaquille O'Neal and NFL superstar Tom Brady have been accused of promoting the now bankrupt FTX crypto exchange, which was accused of accessing and using customer funds without explicit consent and using them for risky bets and trades. In February 2023, Logan Paul was hit with a class action lawsuit over allegedly engaging in a “rug pull”in his CryptoZoo NFT project.  

5. Risk of Hacks

The concept of crypto, in being decentralized and allowing for direct transactions between parties without the need for an intermediary like a bank, while attractive in the sense of cutting out the middleman, also exposes consumers to a higher risk of cyber attacks and hacks, which would have been mitigated by the intermediary’s cybersecurity protections and measures taken to complying with data privacy and cybersecurity laws. Phishing scams to backdoor breaches in 2022 have cost consumers millions of dollars. For example, the Ronin Network blockchain lost USD$ 625 million to a hacker in March 2022, and the Nomad Bridge crypto platform lost USD$ 190 million in August 2022.

6. Lack of Transparency 

Transparency issues can be a major problem in the cryptocurrency market. This can become evident when it is too late for consumers and investors to take action. For example, crypto lender Celsius, which was once a top 10 market leader in the crypto space began to suddenly freeze withdrawals in June 2021, while providing no clear information on why they were freezing withdrawals and whether they would re-open withdrawals. A short time later, Celsius filed for Chapter 11 Bankruptcy in the US Courts, leaving around 4.2 billion worth of investors money in over 600,000 accounts trapped. In a recent update on Celsius’s Bankruptcy filing, the US Court on 4 Jan 2023 has held that Celsius owns most customer crypto deposits, much to the dismay of hundreds of thousands of consumers all around the world.

Similarly, algorithmic stablecoin TerraUSD, which was also a top 10 market leader, suddenly collapsed overnight in May 2022 even though it was supposedly be pegged to the value of the US dollar, costing a large number of consumers to lose about 90% of their investments, causing wide-spread consumer panic and fear, and suicidal ideations, especially those who had invested into the Luna token associated with it, which lost 99% of its value, which was worth  around US$60 billion in market value.

And to top it off, Sam Bankman-Fried, CEO of the crypto trading platform Alameda Research and its retail-facing arm FTX, was arrested in January 2022 on charges of insider trading and market manipulation. There are also serious allegations that FTX had misused customer accounts without explicit consent in risky trades. The charges against the FTX CEO underscores the greater need for increased oversight and regulation in the cryptocurrency industry to prevent frauds and ensure investor protection and confidence in cryptocurrency, which has untapped potential.

As more financial institutions become involved in the cryptocurrency market, the implications for the global economy are becoming increasingly significant. To help protect consumers and the financial system, it is important to address the lack of regulation and transparency in the cryptocurrency market.

Final thoughts

In light of these issues, there is a growing consensus that regulation is needed to protect consumers and harness the potential of the industry. Regulation would provide certainty, security, and stability to the crypto market, and also ensure that consumer protections are in place. However, the question remains on how to regulate such a complex and rapidly changing field. If you want to learn more about how to navigate the regulatory complexities in Australia, the United States and the United Kingdom, read more.

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