Virtual currencies have a lot of features and risks. Virtual currencies include Bitcoin, Ethereum, and a wide range of currencies that enable digital transactions and the delivery of financial products and services in online networks, environments, and marketplaces.
The use of cryptocurrencies as a means of a transaction has also opened the door for criminal activities and other risks to consumers and financial institutions. There are significant risks to using cryptocurrencies. Crypto communities can manage these risks before users can adopt and accept cryptocurrencies to conduct financial transactions on a larger scale.
Risks Associated with Cryptocurrencies
Cryptocurrencies have become the order of the day. As the adoption of cryptocurrencies increases, there are major concerns about the risks involved with cryptocurrencies. Cryptocurrencies were designed to allow people to make transactions without the need of a central supervisor like the banks.
However, this particular feature allows criminals to move illegal funds with ease. They can get illegal funds in crypto and exchange them to fiat without a single trace.
Criminals use virtual currencies to launder money on the dark web, buy and sell illegal drugs, weapons, and services. Most crypto exchanges do not require identity verification. Criminals can create multiple crypto addresses and transfer as many funds as possible.
Using cryptocurrency, many people can effectively avoid taxes. Virtual currency provides anonymity. This is in direct contradiction with the “know your customer” policy that traditional financial systems follow.
Initial Coin Offering
In recent years, companies have used a new approach called “Initial Coin Offerings “to raise funds from investors to fund their startups. ICO is a kind of crowdfunding, in which the company sells newly issued tokens, usually in the form of other cryptocurrencies to raise funds, and then the company can convert it into legal currency to fund its business.
Therefore, it is consequent that ICOs might be vulnerable to ML and TF risks due to the anonymous nature of the transactions, and the ease with which large sums of funds may be raised in a short period and further exchanged to any other VC or fiat money. Furthermore, criminals and terrorists can move huge illegal funds through this avenue and convert them to physical forms of money.
Another major risk with virtual currencies is their high volatility. One can make a 70% ROI on any currency in a week and still lose all that in a day. An excellent example of this volatility is the behavior of bitcoin currently. Within hours, the cryptocurrency fell from above $19,500 to $18,700.
How to Manage Risks With Using Cryptocurrencies
Cryptocurrencies come with their own risks. However, one can manage these risks. Let’s now take a look at three ways to manage these risks.
Implement Structural Mitigants
One way to reduce risk on virtual currencies is to reserve requirements for making transactions in virtual currencies. Exchanges for virtual currencies do not act as custodians of funds. To avoid the risk of extreme volatility and survive any major downturn, exchanges can hold a certain amount of reserves to add an extra layer of protection.
Take Advantage of Technology, and Keep an Eye on Liquidity
The acceptance of digital currencies today is at least partly due to the fact that consumers are increasingly using other mobile payment methods such as Amazon gift cards, Apple Pay, and PayPal.
As the virtual market continues to grow and mature, there may also be increased liquidity. This leads to a tighter bid/ask spread and significantly reduces transaction costs. This will also reduce price volatility, which will reduce exchange rate risk and reduce pressure on risk-averse merchants and consumers to instantly convert cryptocurrencies back into legal tender.
The increase in liquidity will help cryptocurrencies develop characteristics that are more similar to the more widely accepted fiat currencies.
Prioritize Crypto Education
Training and education can go a long way in mitigating the risks and improving confidence in virtual currencies. Today, many horror stories continue to circulate – through social media, mainstream media, and other channels. These stories focus on three principal concerns: spoofing payment information/phishing; hacking a payment gateway; and crypto-jacking.
A comprehensive education package should provide insight into the latest security methods. It should be backed up by anti-malware, backups, cold storage, regular software updates, and strong and frequent password protection. Collectively, when combined with proper training and education, these tools can help mitigate cyber and fraud risks.
Virtual currencies are here to stay. With the number of blockchain protocols and currencies in the world today, it is safe to say that virtual currencies may render traditional payment systems inefficient soon.
However, consumers and financial institutions must not only be smart about the risks associated with virtual currencies but also manage them accordingly.