Main categories of crypto assets

Crypto assets encompass a wide range of digital assets, each with distinct features, purposes, and risk profiles. This guide provides an overview of the main categories, highlighting their characteristics and associated risks to help you make informed decisions.

1. Stablecoins

Stablecoins are cryptoassets designed to maintain a stable value, typically pegged to a reserve asset like fiat currency (e.g., US Dollars). There are two primary types:

• Asset-backed stablecoins are supported by collateral such as fiat currency, commodities, or other cryptocurrencies. Examples include USD Coin (USDC) and Tether (USDT).
• Algorithmic stablecoins rely on algorithms and smart contracts to manage supply without actual reserves. A notable example is TerraUSD (UST), which collapsed in 2022 when its mechanisms failed.

Key risks

• Counterparty risk: Reliance on a third party to maintain reserves. If they become insolvent or mismanage reserves, the stablecoin's value could collapse.
• Redemption risk: During market volatility, redeeming stablecoins for underlying collateral may become difficult, causing delays or losses.
• Collateral risk: The value of backing collateral can fluctuate, especially in commodity- or crypto-backed stablecoins.
• FX risk: Many stablecoins are pegged to the US dollar, exposing non-US investors to foreign exchange fluctuations.
• Algorithm risk: Algorithmic stablecoins can experience price instability if underlying mechanisms fail.

2. DeFi tokens

Decentralized Finance (DeFi) tokens are linked to decentralised applications (dApps) that offer financial services such as lending, borrowing, and trading without intermediaries. These tokens enable users to interact with DeFi platforms in exchange for governance rights, rewards, or transaction fees.

Examples include Uniswap (UNI), Aave (AAVE), and Compound (COMP).

Key risks

• Smart contract risk: Coding errors or security flaws in smart contracts can lead to financial losses if exploited.
• Regulatory risk: DeFi operates in a largely unregulated space, making it vulnerable to regulatory changes.
• Rug-pulls / exit scams: Anonymous development teams increase the risk of projects being abandoned, leaving investors with worthless tokens.
• Oracle / data risk: DeFi protocols rely on external data sources. Incorrect or manipulated data can lead to significant financial losses.

3. Wrapped tokens

Wrapped tokens are digital representations of another cryptoasset, allowing it to be used on different blockchain networks. For example, Wrapped Bitcoin (WBTC) allows Bitcoin to be used on the Ethereum blockchain, and Wrapped Ethereum (WETH) allows Ethereum to be used across multiple DeFi platforms.

Key risks

• Smart contract risk: If the smart contract managing the underlying asset contains flaws or is hacked, the wrapped token's value could be at risk.
• Custodial risk: Underlying assets are held by third-party custodians. If they become insolvent, the wrapped tokens could lose their value.
• Bridging risk: Technology facilitating cross-chain transfers can experience technical difficulties, leading to delays or loss of assets.

4. Meme coins

Meme coins are highly speculative cryptoassets that derive their value mainly from community interest, social media hype, and internet culture. They typically have little to no intrinsic utility. Examples include Dogecoin (DOGE), Shiba Inu (SHIB), and Pepe Coin (PEPE).

Key risks

• Volatility risk: Meme coins can experience extreme price fluctuations driven purely by hype.
• Lack of utility: Most meme coins have no real-world use cases, making them prone to sudden price crashes once hype fades.
• Market manipulation: Meme coins are frequent targets for pump-and-dump schemes.
• Emotional investing: Social media trends can lead to impulsive and irrational investment decisions.

5. Staked cryptoassets

Staked cryptoassets are tokens locked into blockchain networks to support network security and operations. Investors who stake their tokens can earn rewards, but assets are typically locked for a set period. Examples include Staked Ethereum (stETH).

Key risks

• Slashing risk: Validators may be penalised for misbehaviour or technical issues, reducing staked assets.
• Liquidity risk: Staked assets are often locked for a specific period and cannot be sold or transferred quickly.
• APY variability: Staking rewards are not fixed and may fluctuate based on network conditions or protocol changes.

6. Cryptocurrencies

Cryptocurrencies are decentralised digital currencies designed to act as a medium of exchange, a store of value, or both. Examples include Bitcoin (BTC), Ethereum (ETH), and Litecoin (LTC).

Key risks

• Volatility: Cryptocurrencies are known for dramatic price swings, leading to both rapid gains and significant losses.
• Lack of regulation: Cryptocurrencies operate in largely unregulated markets, making them vulnerable to fraud and market manipulation.
• Technology risk: Exchanges, wallets, and supporting infrastructure are prone to outages, cyberattacks, and operational failures.

Diversification of investments

Concentrating your investments in a single asset class can be highly risky. A widely accepted guideline is to limit your exposure to high-risk assets, such as cryptoassets, to no more than 10% of your total investment portfolio.

Diversifying across multiple asset types reduces your dependence on the performance of any single investment. For comprehensive guidance, the FCA's website offers valuable resources. You can also explore the FCA's crypto basics page to learn more about the evolving landscape of digital assets and regulatory measures.