A 51% attack is when a single cryptocurrency miner or group of miners gains control of more than 50% of a network’s blockchain. Such attacks are one of the most significant threats for people who use and buy cryptocurrencies.
The 51% attack scenario is rare, largely because of the logistics, hardware and costs required to carry one out. But a successful block attack could have far-reaching consequences for the cryptocurrency market and those who invest in it.
Cryptocurrency investing can be potentially lucrative but it involves a higher degree of risk compared with stock or bond investing. If an investor is considering adding digital currencies to their portfolio, it’s important to understand the implications of a 51% attack.
Background on 51% Attacks
A 51% attack is an attack on a blockchain, which is a type of digital database in ledger form. With blockchain technology, information is collected together in groups or blocks and linked together to create a chain of data. In cryptocurrency trading, blockchain is used to record approved transfers of digital currencies and the mining of crypto coins or tokens.
With Bitcoin for example, “miners” can attempt to add blocks to the chain by solving mathematical problems through the use of a mining machine. These machines are essentially a network of computers. If miners succeed in adding a block to the chain, they receive Bitcoins in return.
The speed at which all the mining machines within the network operate is the Bitcoin hashrate. A good hashrate can help gauge the health of the network.
A 51% attack occurs when one or more miners takes control of more than 50% of a network’s mining power, computing power or hashrate. If a 51 percent attack is successful, the miners responsible essentially control the network and certain transactions that occur within it.
How a 51% Attack Works
When a cryptocurrency transaction takes place, whether it involves Bitcoin or another digital currency, newly mined blocks must be validated by a consensus of nodes or computers attached to the network. Once this validation occurs, the block can be added to the chain.
The blockchain contains a record of all transactions that anyone can view at any time. This system of record keeping is decentralized, meaning no single person or entity has control over it. Different nodes or computer systems work together to mine so the hashrate for a particular network is also decentralized.
When a majority of the hashrate is controlled by one or more miners in a 51% attack, however, the cryptocurrency network is disrupted. Those responsible for a 51% attack would then be able to:
• Exclude new transactions from being recorded
• Modify the ordering of transactions
• Prevent transactions from being validated or confirmed
• Block other miners from mining coins or tokens within the network
• Reverse transactions to double-spend coins
All of these side effects of a block attack can be problematic for cryptocurrency investors and those who accept digital currencies as a form of payment.
For example, a double-spend scenario would allow someone to pay for something using cryptocurrency, then reverse the transaction after the fact. They’d effectively be able to keep whatever they purchased along with the cryptocurrency used in the transaction, bilking the seller.
What a 51% Attack Means for Cryptocurrency Investors
A 51% attack isn’t a common occurrence but it’s not something that can be brushed off. For cryptocurrency investors, the biggest risk associated with a 51% attack may be the devaluation of a particular digital currency.
If a cryptocurrency is subject to frequent block attacks, that could cause investors to lose confidence in the market. Such an event could cause the price of the cryptocurrency to collapse.
The good news is that there are limitations to what a miner who stages a 51% attack can do. For example, someone carrying out a block attack wouldn’t be able to:
• Reverse transactions made by other people
• Alter the number of coins or tokens generated by a block
• Create new coins or tokens from nothing
• Transact with coins or tokens that don’t belong to them
Investors may be able to insulate themselves against the possibility of a 51% percent attack by investing in larger, more established cryptocurrency networks versus smaller ones. The larger a blockchain grows, the more difficult it becomes for a rogue miners to carry out an attack on it. Smaller networks, on the other hand, may be more vulnerable to a block attack.
Is Cryptocurrency Investing a Good Idea?
Cryptocurrencies can help boost portfolio diversification, but there are certain risks to be aware of. Current cryptocurrency rules and regulations offer some protections to investors, but on the whole, the market is far less regulated than stocks, mutual funds and other securities. Here are some potential upsides and downsides of investing in digital currencies.
Pros of Cryptocurrency Investing
• Bigger rewards. Compared with stocks and other securities, cryptocurrency investing could yield much higher returns. In 2020, for example, Bitcoin surged 159% higher.
• Liquidity. Liquidity measures how easily an asset can be converted to cash or its equivalent. Popular cryptocurrencies like bitcoin are more liquid assets, which may appeal to investors focused on short-term trading strategies.
• Transparency. Blockchain networks offer virtually complete transparency to investors, as new transactions are on record for everyone to see. That can make cryptocurrency a much more straightforward investment compared with more opaque investments like a hedge fund or a real estate investment trust (REIT).
Cons of Cryptocurrency Investing
• Volatility. Cryptocurrencies can be extremely volatile, with wide fluctuations in price movements. That volatility could put an investor at greater risk of losing money on digital currency investments.
• Difficult to understand. Learning the ins and outs of cryptocurrency trading, blockchain technology, and digital coin mining can be more complicated than learning how a stock, ETF or index fund works. That could lessen its appeal for a newer investor who’s just learning the market.
• Not hands-off. If an investor is leaning towards a passive investment strategy, cryptocurrency may not be the best fit. Trading cryptocurrencies generally focuses on the short-term, making it more suited for active traders.
If an investor is still on the fence, they can consider taking SoFi’s crypto quiz to determine how much they already know about this market.
Cryptocurrency investing may appeal to an investor if they’re comfortable taking more risk to pursue higher returns. If an investor is new to cryptocurrency trading, the prospect of a 51% attack might seem intimidating. Understanding how they work and the likelihood of one occurring can help them feel more confident.
If an investor is ready to start trading Bitcoin, Ethereum, and Litecoin, SoFi Invest can help. Members can trade cryptocurrencies 24/7, starting with as little as $10. The SoFi app allows users to manage their account from anywhere.
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Crypto: Bitcoin and other cryptocurrencies aren’t endorsed or guaranteed by any government, are volatile, and involve a high degree of risk. Consumer protection and securities laws don’t regulate cryptocurrencies to the same degree as traditional brokerage and investment products. Research and knowledge are essential prerequisites before engaging with any cryptocurrency. US regulators, including FINRA , the SEC , and the CFPB , have issued public advisories concerning digital asset risk. Cryptocurrency purchases should not be made with funds drawn from financial products including student loans, personal loans, mortgage refinancing, savings, retirement funds or traditional investments. Limitations apply to trading certain crypto assets and may not be available to residents of all states.
Investment Risk: Diversification can help reduce some investment risk. It cannot guarantee profit, or fully protect in a down market.