Coinmetro

Estimated reading time: 7 minutes

Different types of cryptoassets come with their own unique characteristics and risks. Understanding these differences is essential before investing. Below is an overview of key asset categories and the main risks associated with each. This information is designed to help you make informed decisions.

All cryptoassets carry risk, regardless of the type of token you choose to invest in. Before you trade or invest, it’s important to understand the following risks:

• Investment risk: The value of cryptoassets can be extremely volatile. Prices may fall just as quickly as they rise, and you should be prepared to lose all the money you invest.
• Lack of protections: Cryptoassets are largely unregulated. This means you will not be protected by the Financial Services Compensation Scheme (FSCS) or the Financial Ombudsman Service (FOS) if something goes wrong with your investment.
• Cryptoassets are complex: It may not always be clear how a cryptoasset works or what factors influence its value. Take time to research and understand what you’re investing in. If something sounds too good to be true, it probably is.
• Don't put all your eggs in one basket: Putting all your money in a single type of investment is risky. It is good practice not to invest more than 10% of all your money in high-risk investments such as crypto assets.

DeFi tokens relate to decentralised financial applications and protocols that run on public blockchains. These are particularly complex and carry additional risks beyond standard cryptoasset investments:

• Smart contract risk: DeFi relies on smart contracts. Even small coding errors or bugs can lead to exploits, potentially resulting in significant financial loss.
• Regulatory risk: DeFi protocols often operate without intermediaries or standard compliance controls. Future regulation could affect the legality, availability, or value of DeFi tokens.
• Rug pulls and exit scams: Some DeFi projects are launched by anonymous teams. This increases the risk of developers abandoning the project and removing liquidity, leaving investors with worthless tokens.
• Data/oracle risk: DeFi platforms depend on external data sources (oracles) for pricing and execution. If these are manipulated or inaccurate, it can lead to losses.
• Protocol complexity: Many DeFi systems are difficult to understand, even for experienced investors. You should not invest unless you fully understand how the protocol works and the risks involved.

“Memecoins” are cryptoassets whose value is largely driven by community interest, internet trends, and speculative trading, rather than underlying utility or fundamentals. They carry significant risks that investors should carefully consider:

• Volatility risk: Memecoins often experience extreme and unpredictable price swings, heavily influenced by social media trends, celebrity endorsements, and market hype. You should be prepared to lose all the money you invest.
• Lack of utility: Meme coins often lack intrinsic value and utility, relying on community interest and online trends.
• Market manipulation: Meme coins are susceptible to market manipulation, including "pump-and-dump" schemes. It is important to be aware of concentrated ownership, low liquidity, and lack of oversight.
• Community-driven risks: These tokens typically rely on community participation without formal governance structures. If interest fades or a few holders dominate the conversation, the token’s value may drop sharply.
• Emotional investing: Memecoins attract strong emotional responses and viral excitement, which can lead to impulsive or irrational investment decisions and increased risk of loss.
• Lack of transparency: Many memecoins are launched with minimal project documentation or unknown teams, making it difficult to assess credibility or future plans.
• Governance risks: If token holders are given voting power, decisions may be influenced by users with short-term interests or low experience, increasing risk to the protocol and token value.

Stablecoins are cryptoassets that aim to maintain a stable value, usually pegged to a fiat currency like USD. While they are designed for lower volatility, they are not without risk.

• Counterparty risk: If the stablecoin is backed by reserves, a third party is typically responsible for holding and managing those assets. If that party fails, becomes insolvent, or does not maintain the reserves properly, the stablecoin’s value could be affected.
• Redemption risk: The ability to redeem an asset for its underlying collateral may not function as expected, especially during market volatility or network issues.
• Collateral risk: Some stablecoins are backed by other cryptoassets. If the value of the collateral falls significantly, this can destabilise the token and put holders at risk of loss.
• Foreign exchange (FX) risk: Many stablecoins are pegged to fiat currencies (e.g., US Dollars), exposing you to movements in fiat exchange rates.
• Algorithmic risk: Stablecoins that rely on algorithms or smart contracts to maintain their peg can fail due to flawed design, poor execution, or external market shocks. This may lead to a loss of value or stability.

Wrapped tokens (e.g. WBTC, cbETH) are cryptoassets that represent other underlying cryptoassets on different blockchains. They are designed to allow interoperability between networks — but they carry several risks you should understand before investing:

• Smart contract risk: Wrapped tokens depend on smart contracts to maintain their link to the underlying asset. If the contract contains bugs or is exploited, the wrapped token may lose its intended value or Function.
• Collateral risk: The value of a wrapped token is typically backed by an equivalent amount of the underlying asset. If the mechanisms ensuring this collateralization fail, the wrapped token's value might not be preserved.
• Custodial risk: Many wrapped tokens rely on a third-party custodian to hold the original asset. If this custodian is hacked, becomes insolvent, or loses access to the funds, the wrapped token may no longer be redeemable.
• Bridging risk: Wrapped tokens are often created through cross-chain bridges. These bridges can be vulnerable to technical failures or attacks, which could delay or prevent transfers and compromise token usability.
• Price divergence risk: Although designed to mirror the value of the original asset, the wrapped token may trade at a premium or discount due to market imbalances, liquidity issues, or trust in the wrapping process.

Security tokens are digital representations of ownership in real-world or blockchain-based financial assets. They are often subject to securities laws and can carry different rights, such as profit-sharing, dividends, or voting power. These tokens carry specific risks that investors should be aware of:

• Regulatory risk: Security tokens may fall under financial regulations. Offering, holding, or trading them without proper authorisation or in non-compliant environments may be unlawful, and could lead to loss of access or legal consequences.
• Issuer risk: The value of a security token is typically tied to a specific company, project, or asset. If the issuer underperforms, becomes insolvent, or fails to meet its obligations, the token’s value may drop significantly or become worthless.
• Liquidity risk: Security tokens often trade on a limited number of platforms. This can make it difficult to sell your tokens or access fair pricing, especially during periods of market stress.
• Legal complexity: Rights attached to security tokens (such as voting or dividend entitlements) may be hard to enforce, particularly if the issuer operates in a different legal jurisdiction.
• Custody and transferability risk: Security tokens may require specific custody solutions and may not be supported across all wallets or exchanges. Transfers may also be subject to regulatory restrictions, limiting how or where you can trade them.

Governance and utility tokens give holders access to features within a blockchain protocol or allow them to participate in on-chain decision-making. While they may support activity within a digital ecosystem, they still carry a range of risks:

• Project dependency: These tokens are closely tied to the ongoing development and success of a specific platform or protocol. If the project is abandoned or fails to attract users, the token may lose all value.
• Governance concentration: While governance tokens aim to support decentralised decision-making, voting rights may be concentrated in the hands of a few large holders or insiders, undermining community control.
• Volatility risk: Even if designed for use within a platform, governance and utility tokens can still be highly volatile, with prices driven by speculation rather than usage or fundamentals.
• Functionality risk: Some utility tokens may have limited or no actual use beyond speculation. Promised features or applications may never be delivered or may be discontinued.
• Regulatory uncertainty: Some tokens marketed as “utility” may later be reclassified as securities depending on how they function and are used. This could impact how they are offered, traded, or regulated in the future.