To many cryptocurrency newcomers, trading cryptocurrencies/tokens on the cryptocurrency exchange are the same as buying stocks at ETrade or Fidelity. Nothing could be far from the truth. The differences between these two types of trading are many, and they include the following:
The Risk of Insider Trading
There is an inherent risk in every asset for insider trading. In stocks, insiders such as mutual funds and executives are privy to insider information such as the latest financial statements and minutes to boardroom meetings. Cryptocurrencies too have insiders including executives from token issuing companies, mining pools, and large holders. Insiders access the latest information long before outsiders. Thus, insiders could buy or sell depending on whether they expect rallies or selloffs.
And so there is the need to regulate this informational asymmetry to ensure the insiders do not get undue favors. Otherwise, outsiders will see no need to invest, given the likelihood of losing their money. When it dominates the market, unmitigated insider trading pushes investors to the assets where fair trading is still possible for a balanced portfolio.
To protect outsiders, stocks have put in place strict laws and procedure against insider trading. Although not perfect, the system ensures that insiders who trade unfairly face punishment such as reputational damage, jail time, severe fines, and repatriation of profits.
Not so for the cryptocurrencies. Despite its rapid growth, cryptocurrency trading remains unregulated. Many exchanges and altcoin founders operate outside the US in countries such as Singapore and Switzerland. Also, cryptocurrency exchanges don’t collect names or national IDs making it difficult to track and punish unfair trading activities. Exchanges hardly report suspicious activities in governments. Without data, governments cannot categorize legal and illegal activities or convict those involved.
Of course, not all exchanges work the same way, and there are possible solutions. Exchanges with strong KYC procedures, funds, and identity confirmation requirements, can prevent unfair or unlawful trading. Secure and regulated exchanges are still a new thing, but there are already some projects that offer such cryptocurrency trading platforms.
Depositor Security Insurance
Any stocks bought through a broker in the US are eligible for cash and stocks insurance from FDIC and SIPC, respectively to the tune of $500,000 each. Thus, if the brokerage business collapses with your deposits blown to ashes, you will receive a %500,000 reimbursement from the government. Talk about having peace of mind.
This cannot be said about cryptocurrency exchanges. They neither have cash nor asset insurance, except for Gemini and Coinbase which have insurance for cash deposits. Since cryptocurrencies are yet to gain regal recognition in the U.S, they cannot attract security insurance through SIPC.
No Revenue Backing
Publicly traded stocks have the backing of revenue-generating and asset-holding companies. Not so for the cryptocurrencies and tokens, which seem to have cropped up almost from nowhere.
A good example is WeTrust, a company founded in 2016 but which hasn’t released any figures on their user base, revenue or tangible products. Yet the company’s market cap is more than $100 million, as a result of its promise to investors for a part of the value of its product ecosystem. What they did is known as a pre-sale, something on which the company cannot be held accountable when it comes to fulfilling promises made to investors. If it closes shop without warning, the investors will have no legal recourse.
No funds can be raised this way in the stock market where requirements for entry are a little bit stringent.
The Ever Present Risk of Irreversible Permanent Loss
In the cryptocurrency market, there is the lingering risk of a hacker breaking into your account and making off with all your money. The irreversible nature of cryptocurrency transactions means the losses will be permanent. Since you have no legal protection, trying to sue the exchange will backfire. If it declares bankruptcy you will be left with huge losses. In 2017 alone, over $150 million was lost through high-profile cryptocurrency hacking incidences. Actual losses could be higher, given many people never report losses.
Of course, phishing and scams also affect stocks. However, stocks and money deposits can never disappear without a trace given that money wired to the hackers can be reversed. No such case where a stock brokerage lost customer assets or funds permanently has occurred recently.
Price Inconsistency across Exchanges and Order Protection
The SEC guarantees that limit stock orders aren’t filled by a price worse than the best bid or best offer across all exchanges. This ensures a balanced portfolio. Not so for cryptocurrencies where exchanges are under no legal obligation to price match or price improve. As a trader, you should be very careful when choosing the best cryptocurrency exchange.
As you can see, stock trading across the world is regulated by strict laws protecting investors. As for cryptocurrency trading, it remains unregulated and most exchanges are independent of the jurisdictions of any country. If you choose to invest in cryptocurrencies, you risk losing all your money.