The twelve biggest crypto investing mistakes and how to avoid them

1 - Not being emotionally ready for a very bumpy ride

Everyone knows that crypto assets exhibit very high price volatility, but not everyone is aware of just how extremely volatile they tend to be. The most famous crypto is Bitcoin. In its roughly 12-year life, its price has decreased more than 75% on three separate occasions.

Every four years so far, the performance of Bitcoin has seen drawdowns that were about as steep as the strongest decline that equities witnessed during the last 100 years. Compared to free-floating cryptos, the price volatility of other assets pales in comparison.

Cryptos other than Bitcoin have often exhibited even more volatility. Out of the top 10 cryptos by market cap from 2013, only one remains in the top 10 today. Eight out of 2013’s top 10 are not even part of the top 800 anymore, thereby largely drifting off into obscurity.

From 2016’s top 10 cryptos by market cap, only three are still in the top 10. It is important for potential crypto investors to remind themselves often that massive price shifts are the norm rather than the exception for free-floating cryptos. They need to be emotionally prepared for an extremely likely bumpy ride.

2 - Thinking a low token price must be a bargain

Just because a crypto token has an extremely low per-unit price in US dollars does not necessarily make it a bargain. The price of an individual unit of a token without context is close to meaningless. The creators of a token can decide how large the supply of coins or tokens can be. There is zero effort difference between creating a Bitcoin clone that will have a maximum coin supply of 21 million coins from one that will have 21 trillion coins. This is somewhat similar to fiat currencies.

At the time of writing, one US dollar was currently worth a bit more than 20,000 Vietnamese Dong. This is just the exchange rate. It does not by itself indicate in any way whether the Dong is undervalued versus the dollar or not.

Instead of looking at the price of a crypto token, investors need to look at the price in the context of total tokens in circulation as well as future token supply dynamics and the general promise of the token adding practical value to the real world.

3 - Forgetting to diversify

There is a general adage in the world of finance: “Never put all your eggs in one basket”. This call to diversification rings particularly true in the world of cryptos. The holder of a corporate bond is likely to still get something back during the liquidation if the issuing company goes bankrupt. The owner of a house still has a place to live during a real estate crisis. In the realm of crypto, a shift in user preferences or big code base errors can potentially make a coin or token nearly worthless overnight. It can therefore be seen as prudent to diversify between two dimensions:

Cryptos have exhibited less than perfect correlation with other types of financial assets such as stocks or bonds. Investors should ask themselves what the ideal asset mix between cryptos and traditional financial instruments would look like to reflect their risk preferences and return expectations.
Not all cryptos try to do the same thing. Some can be categorised as payment tokens, having a function that is, in the broadest terms, similar to the US dollar or gold. Others can be categorised as infrastructure tokens, aiming to provide a platform that decentralised finance applications are built upon. Yet others can be seen as service tokens, e.g. systems that oracle services that bridge the information gap between the physical world and the crypto world. Just as an equity investor might not want to hold only pharmaceutical company stocks but also titles from other sectors, a crypto investor might want to hold coins or tokens from cryptos that inhabit different financial functions and therefore potentially possess different price movement characteristics.

4 - Falling victim to FOMO

The fear-of-missing-out, often abbreviated as FOMO, is nigh omnipresent in the crypto space. Every second post related to potential future crypto price performance seems to be accompanied by projections that the price will go “to the moon”, often followed by multiple dollar signs and rocket emojis. It is difficult not to get caught up in a tidal wave of optimism about potential future riches, particularly when the price chart looks like a green line shooting straight up. Investors must always stay as level-headed as possible. The two biggest enemies of the investor are greed and fear.

Just because a coin has exhibited a spectacular price performance in recent times does not necessarily mean that this trend must continue. Always do your due diligence. There have been multiple occasions where malignant actors pushed fake news reports about cryptos to influence their price. Pump-and-dump schemes in the space are not uncommon.

When you spot an influencer posting positively about a coin or token, ask yourself whether the influencer is getting paid to do so and, if so, by whom. When there is an extremely positive news article about a coin or token, particularly about one with a low market capitalisation, double-check the validity of the information.

5 - Falling victim to scams

Potentially even worse than buying a massively overhyped product, is buying something that never had any value to begin with. Unfortunately, the novelty of cryptos has attracted many scam artists to the space. Ponzi schemes have run rampant in the space, often in the form of so-called high-yield investment programmes. Endeavours such as PlusToken, USI Tech, OneCoin, and Bitconnect have managed to scam individuals out of many hundreds of millions of dollars. The blockchain data firm Chainalysis estimates that scammers were able to steal over USD 7.7 billion in 2021, an 81% increase versus the previous year.

To avoid these types of scams, it often helps to read through the published white paper. This document is available for most cryptos and details what problem the crypto wants to solve and how it plans to go about doing so. No white paper or one that does not hold up to intellectual scrutiny is a red flag.

Furthermore, it helps to look up the credentials of the main contributors. How much experience do they have in the crypto field? Have they ever been at odds with the law? Another indicator is who else is invested. Large-cap companies and established venture capital firms tend to do fraud-related due diligence before investing. If you spot them as investors, then that is a positive puzzle piece in your due diligence efforts. Sometimes, just a big portion of common sense is enough though. Bitconnect promised a daily return of at least 1%. Due to the compound interest effect, a daily return of 1% results in an annual return of 3,678.34%. Such financial returns are extremely unlikely to be achieved once and even less likely to be sustained over longer periods. Two general investment adages are important here: First, never invest in something you do not fully understand; second, if it sounds too good to be true, it probably is.

6 - Investing money you cannot afford to lose

“Never invest what you can’t afford to lose” is often called the golden rule of investing. In few places does that ring more true than in the crypto market. Many of the early payment cryptos have drifted into obscurity. In the exiting space of decentralised finance, while some cryptos might increase in value a thousand-fold, some will likely be left completely on the wayside. With tremendous upside potential comes a gut-wrenching risk of loss.

Investing should always be a process where you work backwards. Ask yourself what your financial goals are (e.g. house in five years, large donation in ten years, large and well-diversified portfolio at retirement age), and then figure out which sort of asset mix is going to maximise the chances of you reaching all those goals.

7 - Forgetting the passcodes…

When you lose your bank cards, you can go to a bank branch and get a replacement. It is not the end of the world. If you can verify your identity with a document like a passport or driving license, you will still have access to your funds. Not so in the crypto space if you decide to do custody yourself.

Losing your private key, a string of numbers and letters needed to make crypto transactions means losing access to the associated funds. There are no do-overs. Stefan Thomas, who used to be the Chief Technology Officer of a key player in the crypto space, once received a present of 7002 Bitcoins in 2011. Unfortunately, he lost the necessary password. He has since made peace with the resulting loss of more than USD 300 million at current market prices.

When deciding to store cryptos yourself, it is paramount to store passcodes in such a way that they can be retrieved reliably. Always have at least one well-protected backup of your passcodes.

8 …or not protecting the passcodes well enough…

While it is important to have passcode backups that are reliably retrievable, it is also paramount that the passcode cannot be retrieved by anybody other than yourself. When creating a passcode for your crypto funds, the general rules concerning passcodes apply:

Never use the same passcode for your crypto funds that you already use for your email account or other login credentials.
Do not use passcodes that you have used previously.
Do not focus on personal information, e.g. your spouse’s name or your birthday.
Avoid easy-to-guess segments in your password, e.g. 1234, password, or qwerty.
Length tends to beat complexity, e.g. 3e&%Bt takes roughly four minutes to crack according to random-ize.com, while rang8brownJBsquareROUTE12&%? would take an Octillion (a billion billion billion) years in a brute force attack.

The greatest passcode is only as safe as the place where it is stored. Having the passcode in a Word file on your desktop is highly discouraged. Similarly, having the passcode printed out on a piece of paper and stored prominently in the top drawer of the bedside cupboard is not a good idea either. The best storage places are physical places like hidden safes and bank vaults.

9 …or entrusting the passcodes to unsafe firms

Instead of storing cryptos oneself, a custodian can take care of the storing process. Investors, however, need to be very careful about whom they entrust with their crypto wealth. Crypto exchanges might appear to be the most convenient solution, but they have, at times, exhibited unsatisfactory safeguarding episodes. Mt. Gox, NiceHash, Coincheck, Zaif, BitMart, and Cream Finance are only a few crypto exchanges that have lost investor funds of USD 50 million or more in recent years.

One should not hold all fund passcodes in an exchange with a sketchy past, a questionable compliance set-up, or which is incorporated in a part of the world where legal investor protection standards are not strictly enforced. Instead, investors should only hold their funds with one, or preferably multiple, custodians that they can trust. It is also a good idea to hold crypto in a tiered approach. Funds that do not need to be available should be held in so-called cold storage, a method that is safer but takes more time to access when crytos need to be used in transactions.

On the other hand, funds that need to be readily available should be held in so-called hot storage solutions. Just as with refrigerators, the bigger the part of the groceries that you can put into cold storage, the more likely you will still have something to enjoy in the long run.

10 - Bragging online about crypto wealth

Bragging online about having reached crypto riches is similar to shouting out into the world’s largest town square to all cybercriminals: “Hey, I’m worth your effort…”

While it might be tempting to post a screenshot of the crypto wallet’s balance on social media after a period of great performance, it is not wise to do so. According to a recent report by Chainalysis, scammers stole a record USD 14 billion in crypto in 2021. Crypto gains social media ego-boosts are the equivalent of painting a target on one’s back. Do not do it.

11 - Making transaction typos

The immutability of the blockchain ledger is generally a key strength of the technology, but it also has its dark side. Transaction mistakes can be exorbitantly costly. When you type in the wrong IBAN address in a traditional financial transaction, the resulting problem can be rather easily reversed. This is pretty much never the case with blockchain-based transactions. What is done tends to be, well, done.

There are many stories of individuals who saw their funds getting deducted from their wallets without reaching their proper destination because there was a typo in the recipient address, a so-called “fat-finger error”. On 14 December 2021, a trader of the Bored Ape Yacht Club NFT (non-fungible token) wanted to sell a particularly rare specimen for 75 ether, the rough equivalent of USD 300,000. Unfortunately, he typed 0.75 ether instead, thereby selling it for just USD 3,000.

What has occurred multiple times is for market participants to mix up the transaction amount field with the transaction fee field, thereby generating a nice surprise for the crypto miners and a nasty one for the recipient. Any crypto transaction needs to be triply and quadruply checked. The repercussions from a typo are much more severe compared to transactions in the traditional financial world.

12 - Not thinking about the taxman

Benjamin Franklin once proclaimed, “in this world nothing can be said to be certain except death and taxes”. While tax collecting agencies have been many steps behind the crypto industry in the past, they are catching up quickly.

First, investors need to know how their jurisdiction treats cryptos. Is a wealth tax applicable on the holdings? Are profits categorised as regular income, as a capital gain, or maybe not as a taxable event? Second, investors will need to build the necessary corresponding accruals. Spending all crypto profits on luxurious holidays could lead to unwelcome surprises when the next tax season comes around.

Tax evaluations are not the most exciting topic when it comes to the fascinating and rapidly evolving field of cryptos. However, it is very important to consider these and failing to do so is one of the 12 most common traps that investors can fall into in the realm of crypto.