Additional information about cryptoasset types and risks
Before buying cryptoassets, please take time to understand the different risks associated with the different types of cryptoassets and the steps you can take to mitigate certain risks.
- Decentralised Finance (DeFi) tokens
- Meme coins
- Stablecoins
DeFi tokens
DeFi tokens are crypto-assets linked to financial applications and protocols built on decentralised blockchain technology.
- Technical linked risks:
- Smart contract risk: DeFi relies on smart contracts. A coding error or oversight can lead to a contract being exploited, potentially resulting in significant losses.
- Data/oracle risk: DeFi protocols often rely on external data sources or ‘oracles’. Manipulation or inaccuracies in these data sources can lead to unintended financial outcomes within the protocols.
- Protocol complexity: The complexity of some DeFi protocols make it difficult for average users to fully understand the mechanisms and associated risks.
- Smart contract risk: DeFi relies on smart contracts. A coding error or oversight can lead to a contract being exploited, potentially resulting in significant losses.
- Regulatory risk: DeFi operates in a decentralised manner, often without intermediaries or financial crime controls. Regulators may impose rules impacting the use, value, or legality of certain DeFi protocols or assets. Where multiple jurisdictions are used, this risk increases significantly.
- Rug-pulls / Exit scams: Some DeFi projects might be launched by anonymous or pseudonymous teams, increasing the risk of “rug pulls” where developers withdraw funds before abandoning the project, as investors panic to sell, the price crashes, often to zero.
- Volatility linked risks:
- Whale movement risk: Large account holders can flood the market causing prices to drop suddenly. This is another form of volatility risk.
Meme coins
‘Meme coins’ are crypto-assets whose value is driven primarily by demand led by community interest and online trends.
- Volatility linked risks:
- Fashion risk: Meme coins can be fashion fads that come and go, making them highly volatile. The value of meme coins can be influenced by social media trends, celebrity endorsements, and other factors unrelated to traditional investment fundamentals.
- Pump-and-dump: Meme coins may be susceptible to increased risk of market manipulation including ‘pump-and-dump’ schemes, where promoters drive demand then sell up before anyone else.
- Lack of interest: Fashions come and go. As new coins are created, people may lose interest in old ones.
- Fashion risk: Meme coins can be fashion fads that come and go, making them highly volatile. The value of meme coins can be influenced by social media trends, celebrity endorsements, and other factors unrelated to traditional investment fundamentals.
- Lack of utility: Meme coins often lack intrinsic value or utility, being primarily driven by community interest, online trends, and speculative trading.
- Lack of transparency: Typically, there’s limited information available about their development teams, goals, and financials. This lack of transparency can make it challenging to assess the credibility and the potential of a meme coin accurately.
- Emotional investing: Don’t invest impulsively – Meme coins provoke emotional investment decisions, leading to impulsive investments that can be regrettable.
Stablecoins
‘Stablecoin’ means that the manufacturers claim their value is linked to certain assets, such as US Dollars. Stablecoins use a different strategy to maintain stability, each with their own risks.
- Counterparty risk: If an asset is backed by collateral (e.g. cash) you are relying on a third party to maintain that collateral which introduces risk if the party becomes insolvent or otherwise fails.
- Redemption risk: During periods of market volatility, uncertainty, or distress. If the asset claims to be redeemable for underlying collateral, there is risk that the redemption process will not work as expected.
- Collateral risk: The value of the collateral may fluctuate, affecting the stability of the asset (especially if it is another cryptoasset).
- FX risk: Lots of stablecoins are denominated in US Dollars, thereby exposing you to movements in the USD:GBP exchange rate
- Algorithmic risk: If an algorithm is used to maintain stability (e.g. by adjusting supply based on demand) it may fail or fluctuate, which may cause instability or even total loss.