Written By: Adrian Moore – Forex Focus
Investors are hopping on to the cryptocurrency bandwagon, with reports of cryptocurrency mining and the bitcoin fork coming out. Will the cryptocurrency prove its mettle, or is it just a designer currency that is a passing fad? To understand if this new currency has the potential to replace or exist alongside existing currencies, considering the risks and rewards is absolutely essential.
A cryptocurrency is a decentralized digital currency that is not subject to any governmental control. Working much like a fiat currency, it can be exchanged for conventional currencies such as dollars, yen, etc. Because it has no physical form, it cannot be withdrawn from an automated teller machine (ATM) or a bank. Does this translate into opportunities or challenges? Because it exists only in the digital space, using it for offline purchases can be challenging. But cryptocurrencies do offer a lot of opportunities, too. Here are some of the risks and rewards of investing in cryptocurrencies in 2018.
#1 Increase in volatility
Cryptocurrencies are more prone to volatility when compared to investments in conventional financial instruments, such as equities, commodities, forex (foreign exchange) or even real estate. Massive fluctuations in prices are routine. Bitcoin, for instance, oscillated between $10,800 and $19,300 in December 2017. Such volatility is unheard of in traditional financial instruments.
#2 Network issues
Another issue that needs to be tackled is the significant network of users. Given that its true value relies on building a strong network of users, if a network fails to attract users (or to function due to the lack of them), the price of the digital currency is likely to fall. There are examples of a number of cryptocurrencies that failed post their launches on account of inadequate network engagement.
#3 The pitfalls of a virtual currency
Unlike established currencies that have the backing of the government and the central bank of the country, the value of cryptocurrencies boils down to computers and math. There are no physical coins or notes and no central repository. Because it is virtual, a backup currency is required in case the system crashes. Without physical backup, the entire balance can be wiped out in a single moment.
#4 Tech burglars
Hacking is one of the biggest security threats; as cybercriminals become more advanced in their approaches, cryptocurrencies become increasingly vulnerable to high-tech thieves. In fact, hacking can lead to dips in their market values as investors tend to stay away from investments that are exposed to theft.
#5 Speculative investment
This is a highly speculative form of investment. In 2016 alone, more than US$50 million was stolen from the
DAO cryptocurrency fund. Violent market corrections and the pulse of the digital-currency community can be extremely difficult tasks for investors to monitor.
#6 Understanding the global picture
The current global scenario points to the risks associated with cryptocurrencies. The Central Bank of Russia has come down on digital-currency exchanges. The Chinese government has also blocked investments in cryptocurrencies because of the massive scope for corruption. Given that Japan declared cryptocurrencies as legal tender, the picture remains dubious. While JPMorgan Chase has announced its opposition to bitcoin, Goldman Sachs is rumored to be moving toward the currency.
#7 No intrinsic value
Virtual currencies typically have no intrinsic value. They derive their value from investor demand alone. While digital currencies can be transferred without financial intermediaries, transactions are verified only by computers susceptible to failures.
It’s hard to predict their long-term potential since investing in cryptocurrencies is like investing in any risky venture. As the debate around the value of investing in cryptocurrencies grows, let us consider the benefits of investing in these digital currencies as well.
#1 Potential for return
Cryptocurrencies are digital in nature, so investors see the opportunity in using these as speculative investments for the future. As the value of the digital currency swings over a period of time, the potential for returns in the short- as well as the long-term is immense.
#2 Ease of transfer
Ease and security of transferring funds between people or businesses in a transaction is another bonus of investing in cryptocurrencies. Private and public keys ensure the security of the transaction. Fund transfer fees are also minimal.
Online ledger blockchains can be transferred to computers and ensure greater accountability. Verifying transactions provides a lot of transparency and keeps investors in the loop. While cryptocurrency ICOs (initial coin offerings) come with volatility or risk, huge returns on investment offset the speculative aspects of the investment. Consider an investment of US$1,000 in bitcoin in 2013, which would be worth more than $400,000 today!
#4 Massive returns
ICOs have created massive returns in a short period of time. For example, in June 2016, Stratis raised $600,000 during an ICO and observed a 63,000-percent rise in the price. In January 2016, Spectrecoin raised $15,000 during the ICO, which has since risen more than 13,000 percent. Cryptocurrencies are no doubt risky, which is why they are sometimes compared to VC (venture capital) investments.
Investing in cryptocurrencies requires specialized knowledge, and its rampant growth has led to massive volatility, which will no doubt remain for as long as the market for cryptos continues to exist. Digital currencies are generally encrypted, and as governments spend more and more resources towards decryption for security reasons, it is only a matter of “when” the network will be compromised.
In addition, the decentralized nature of the network and the hacks that have already led to the closures of some of the exchanges put the entire onus on the buyers as risk-takers. Notwithstanding the pros and cons associated with investing in them, weighing the risks versus rewards can be the best way to move forward on whether cryptocurrencies are the right choice for an investor or not. To put it another way, cryptos are for the fun-loving and for investors who have a large risk appetite. However, for investors looking to grow their portfolios, the right option would likely be to stick to traditional asset classes.