The Dark Side Of Crypto: Losing More Than You Invest

Investing in crypto is risky, and it's possible to lose more than you initially invested. If you use a broker that does not offer negative balance protection, you can lose more money than you have invested. Additionally, if you borrow money to invest in crypto, you will have to pay back the loan plus interest, which can result in losses greater than your initial investment. However, if you directly buy crypto with your own money, the maximum loss you can incur is the amount you invested.

You can't lose more than you invest if you use a cash account

Investing in the stock market or cryptocurrency always comes with some level of risk. However, if you use a cash account, you cannot lose more money than you put in.

With a cash account, you are required to pay the entire amount of a security using cash or settled proceeds from the sale of other securities. This means that you cannot borrow money from a broker to purchase a security, a practice known as investing on margin. As a result, you cannot lose more than your initial investment, even if the stock price drops to zero.

Cash accounts are a suitable option for beginner investors as they limit potential losses to the initial investment. In contrast, margin accounts allow purchases with borrowed money, increasing the risk of losing more than the current value of the investment.

While cash accounts protect you from losing more than you invest, they do not eliminate all risk. It is still possible to lose your entire investment if the stock price drops to zero. Additionally, cash accounts have certain drawbacks, such as settlement periods that can delay access to funds after a sale.

Overall, if you are looking to minimise the risk of losing more than your initial investment, a cash account is a safer option compared to margin accounts or other advanced investment techniques.

You can lose more than you invest if you use a margin account

When investing in crypto, it is important to understand the risks involved. While the potential for high returns exists, there is also the possibility of losing money.

In general, if you directly buy crypto assets with your own money, the worst that can happen is that the asset loses all its value, and you lose the amount you invested. However, if you use leverage or margin accounts to invest in crypto, you can lose more than you initially invested.

A margin account is a type of brokerage account where the broker lends the investor cash to purchase crypto or other financial products. This allows investors to increase their purchasing power and trade with more money than they have in their account. While this can magnify profits, it can also lead to magnified losses.

For example, if you invest $2,500 of your own money in a margin account and borrow an additional $2,500 from the broker to purchase a crypto asset worth $5,000, you have the potential to double your profits if the asset appreciates in value. However, if the asset declines in value, you will not only lose your initial investment but also owe the broker the borrowed amount plus interest. In this case, if the asset drops to $2.50, you would lose your entire $2,500 investment, and the broker would notify you of a margin call, requiring you to put more capital into the account to cover the loss.

It is crucial to understand that when using margin accounts, the potential for loss is greater than the amount deposited in the account. This is why margin accounts are only suitable for sophisticated investors who thoroughly understand the risks and requirements of trading on margin.

To protect yourself from losing more than you invest, it is recommended to use brokers or platforms that offer negative balance protection. This feature ensures that your losses will not exceed the total value of your deposited money.

Crypto is volatile, so you could lose practically everything in an instant

Crypto is a highly volatile asset class, and investing in it can be a rollercoaster. Cryptocurrencies can gain or lose significant value in a single day, and this volatility is a lot easier to stomach when it's hypothetical or when you have a small portion of your portfolio in crypto. When crypto makes up 100% of your portfolio, the volatility becomes stressful.

For example, if you had invested in 1 Bitcoin at the start of 2020, it would have cost you $7,195. Here are some of the ups and downs you would've experienced if you held on to your 1 Bitcoin:

• April 14, 2021: $63,577 (up 784%)
• July 21, 2021: $29,972 (down 53%)
• Nov. 10, 2021: $69,045 (up 130%)
• Nov. 9, 2022: $18,562 (down 73%)

As you can see, the value of your investment could have swung dramatically in a short period. This kind of volatility is exciting when it's in your favour, but it can be devastating when it's not.

The extreme volatility of crypto means that you could lose practically everything you invested in an instant. For this reason, it's crucial to only invest an amount of capital that you are fully prepared to lose. At the very least, ensure you have enough emergency savings before putting any funds into crypto. Once you're ready to invest, make it no more than 5% of your portfolio to limit the impact of losses.

Additionally, consider using dollar-cost averaging for crypto, which involves making small, recurring purchases on a set schedule, such as weekly or monthly. This approach helps to reduce the impact of volatility by buying relatively more crypto when prices drop and less when they rise.

Remember, crypto investing is highly speculative, and it's essential to be prepared to cut your losses if investment theses change.

You can lose more than you invest in crypto if you use leverage

Investing in crypto is risky business. Crypto is extremely volatile, and you could lose practically everything you invested in the blink of an eye. However, it is generally not possible to lose more than you invest unless you use leverage.

Leverage is a trading instrument used to enable margin trading. In other words, it is a way to borrow capital to make larger trades. Leverage allows you to trade with more capital than what you currently have in your wallet. For example, if you have $5,000 in your account but want to buy Bitcoin (BTC) which is currently worth $10,000, you can take out a loan to make up the difference. This is known as 2x leverage, as half of your assets are loaned and the other half is yours.

The higher the leverage, the greater the risk. While leverage can amplify your profits, it can also amplify your losses. For instance, if you have $1,000 in your account and invest it in Ether (ETH) with 10x leverage, the initial margin required would be $100. If the price of ETH drops by 20%, your position would be down $200. Since your initial margin is only $100, a 20% drop would trigger liquidation.

Leverage trading is often done through margin trading, futures contracts, and options contracts. It is a popular but risky strategy, especially during periods of high volatility. It is important to understand how leverage trading works before taking on the additional risks.

Crypto exchanges are a popular target for scammers

• Keep your login information safe and create strong passwords.
• Be cautious of phishing scams, which may involve scammers pretending to be from a crypto exchange or support team.
• Be aware that crypto exchanges are not always safe, as seen with the collapse of FTX.
• Consider using a crypto wallet to store your cryptocurrency, rather than an exchange. This gives you full possession of your crypto, but be aware that if you lose access to your wallet, you may not be able to recover your crypto.
• Only use well-known and trusted crypto exchanges.
• Be cautious of any unsolicited messages or communications about your crypto. Always verify the sender's identity and contact information through official channels.
• Be wary of any offers or investments that seem too good to be true, such as guaranteed returns or overnight wealth.
• Be cautious of romance scams, where someone pretends to be interested in you romantically to gain your trust and then tries to get you involved in crypto investments.
• Report any suspected scams or fraudulent activity to the relevant authorities, such as the Federal Trade Commission (FTC) or the Federal Bureau of Investigation (FBI).

Frequently asked questions