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What are the crypto valuation risks?

While it is not entirely fair to label DeFi markets as being the ‘wild west’, neither is it as ‘safe’ as traditional investment opportunities.
business person looking at stock prices

In addition to the lack of generally accepted valuation models that make valuation and pricing of crypto-assets difficult – adding to volatility and investment uncertainty – there are other risks that users should be aware of.

Valuation risks

  1. Lack of regulation. A lot of regulation that exists provides investor protection. Regulation protects investors from unscrupulous promoters who attempt to get investor to buy otherwise worthless assets at high prices.
  2. Lack of standardisation. Financial products traded on traditional markets are standardised. This means that investors need only focus on the investment characteristics of the product itself and not have to also focus on the unique features of each product.
  3. Novelty. Many crypto-assets being traded are new to the world with few if any actual use case. In the non-crypto world many new products and concepts fail, so too we can expect many crypto-assets to fail.
  4. Technical proficiency. At the time of writing investment in DeFi requires a high degree of both digital literacy and financial literacy.
  5. Technical limitations. Trading on a blockchain can be both slow and expensive in terms of execution fees.

The returns that DeFi investment offer appear to be very high when compared to returns in traditional finance, but we need to recall the risks that users face in these markets are very high too. In particular many of these risks are not faced by investors in traditional markets – or they highly ameliorated in traditional markets.

While it is not entirely fair to label DeFi markets as being the ‘wild west’ as some regulators have done, neither is it as ‘safe’ as traditional investment opportunities. Users need to be aware that many of the practices that have been regulated away in traditional markets (such as insider trading for example) still exist in DeFi markets. It is easy to quickly lose money when trading in DeFi markets and the maxim ‘buyer beware’ very much applies.

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Decentralised Finance: Blockchain, Ethereum, and The Future of Banking

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