Crypto Investment: Worthwhile Or Risky Venture?

Investing in cryptocurrencies is a hot topic in the financial world, with Bitcoin being the most well-known and widely used digital currency. It's hard to predict whether this cryptocurrency will become the global reserve currency or a store of value as widely accepted as gold. While some individuals believe in the potential of Bitcoin as a decentralized currency and store of value, leading them to consider it a good long-term investment, others warn of its volatility and lack of regulation. So, is crypto a good investment?

Volatility

As a relatively new asset class, crypto is widely considered to be volatile. Crypto has witnessed significant upward and downward movements over shorter time periods. For example, in one day, Bitcoin's value dropped by 30%. Crypto's volatility is partly due to its speculative nature, as its market value is based on speculation and investor expectations. The immature nature of the digital asset space also contributes to crypto volatility. The market is still in its early and high-growth phase, with investors still finding their feet.

The crypto market's lack of regulation also plays a role in its volatility. Without clear regulations, the market is susceptible to panic selling and destructive events. Additionally, the relatively small size of the crypto market means there is less liquidity and depth to accommodate larger traders, making it difficult for them to enter or exit the market without affecting prices.

The distribution between supply and demand also influences crypto volatility. The limited supply of certain crypto assets, such as Bitcoin, can lead to increased upward pressure on prices when there is a sudden increase in demand. This can result in even greater volatility.

While crypto's volatility can be a concern for investors, some view it as an opportunity for high returns. For risk-averse investors, there are strategies to limit the downside impact of volatility, such as dollar-cost averaging and investing in stablecoins, which are cryptocurrencies designed to have low volatility.

Security and fraud

Cryptocurrency fraud has become a dominant topic of discussion for government enforcement attorneys, with numerous conference panels and agency bulletins addressing its various forms, the hype versus the reality, and the many ways it can facilitate fraud. As crypto scams become more common, whistleblowers will continue to play a crucial role in helping the SEC, CFTC, and IRS with their enforcement efforts.

Types of Cryptocurrency Fraud

• Scam Initial Coin Offerings (ICOs): Many ICOs are completely fabricated, with phony bios of non-existent team members and technical whitepapers copied from other legitimate cryptocurrencies.
• Pump and Dump Schemes: Crypto provides a new variation of the classic pump-and-dump scheme, where false claims are used to hype up demand and allow the dominant holders of the cryptocurrency to sell their holdings at an artificial peak.
• Market Manipulation: Fraudsters can attempt to manipulate the markets where cryptocurrencies or related derivative products are traded. Improper market manipulation may include spoofing, front-running, churning, and other schemes.
• Ponzi Schemes: Crypto investments can be used as the vehicle for a traditional Ponzi scheme, where new adopters are necessary to give artificial returns to early adopters.
• Wallet and Exchange Scams: Criminals can hack investors' crypto wallets and steal their currency, or they can set up fake wallets and phony crypto exchanges to steal customers' money.
• Unscrupulous Promoters: Celebrities and influencers may be paid to promote investments in ICOs without disclosing that they have been compensated to do so.

Protecting Yourself from Crypto Scams

• Understand the Risk: The virtual currency trade is speculative and volatile. An investment that may be worth thousands of dollars today might be worth only hundreds tomorrow.
• Resist Pressure to Buy Now: Criminals often try to create a false sense of urgency around a supposedly red-hot cryptocurrency.
• Do Your Research: Thoroughly research any virtual currency platform or digital wallet provider before providing any credit card information, wiring money, or disclosing sensitive personal data.
• Be Wary of High-Pressure Sales Tactics: Only scammers will demand payment in cryptocurrency or guarantee profits or big returns.
• Never Mix Online Dating and Investment Advice: If someone you meet on a dating site or app offers you investment advice or asks you to send them crypto, that's a scam.
• Be Aware of Celebrity Impersonation Scams: Scammers impersonate celebrities, contacting fans through social media to offer a chance to make a killing on a cryptocurrency investment.
• Report Fraud: If you've been targeted by a crypto scam, submit a report to the FBI Internet Crime Complaint Center (IC3) or your local police department. You can also file a report through the FTC's online form at ReportFraud.gov.

Regulatory uncertainty

Investing in cryptocurrencies is risky due to regulatory uncertainty. Cryptocurrencies are not regulated by any central government authorities, making them immune to government interventions. However, this also means that they are subject to greater regulatory uncertainty. Crypto investors face the risk of regulatory crackdowns, especially if governments view cryptocurrencies as a threat rather than an innovation. For instance, the Securities and Exchange Commission (SEC) in the United States has filed enforcement lawsuits against several players in the cryptocurrency sector.

The regulatory landscape for cryptocurrencies is complex and constantly evolving. Some countries, like China, have banned cryptocurrencies entirely, while others, such as El Salvador and the Central African Republic, have adopted Bitcoin as legal tender. In the US, several government agencies oversee and regulate the cryptocurrency industry, including the Financial Crimes Enforcement Network, the Securities and Exchange Commission (SEC), the Commodities Futures Trading Commission, and the US Treasury Department.

The lack of clear and consistent regulation across countries has led to concerns among investors and businesses. Ken Griffin, the founder of Citadel Securities, one of the world's biggest market-making firms, stated that his company does not trade cryptocurrencies due to regulatory uncertainties. He highlighted the need for thoughtful regulation around cryptocurrencies, predicting that it would make the market smaller and more competitive.

The regulatory uncertainty surrounding cryptocurrencies has also created challenges for privacy and security. Cryptocurrencies are often associated with anonymity and privacy, but in reality, transactions can be traced back to their wallet addresses. This has raised concerns among regulators about money laundering and terrorist financing. As a result, privacy coins, which offer enhanced privacy features, have faced increased scrutiny and even bans in some countries like South Korea and Japan.

While the regulatory landscape for cryptocurrencies remains uncertain, there are ongoing efforts to establish clear frameworks. Some members of Congress in the US are pushing to create a regulatory framework for crypto by the end of the year. Additionally, international organizations like the Financial Action Task Force (FATF) have released guidance for firms handling cryptocurrency and virtual assets, increasing transactional reporting requirements.

In conclusion, regulatory uncertainty is a significant factor to consider when investing in cryptocurrencies. The lack of clear and consistent regulation across countries can impact the liquidity and stability of the market. While some countries have taken steps towards recognizing and regulating cryptocurrencies, the overall regulatory landscape remains uncertain. Investors should carefully consider these regulatory risks before deciding to invest in cryptocurrencies.

Inflation protection

Investing in cryptocurrencies is risky due to the potential for high losses from security breaches and fraud. However, some people view cryptocurrencies as a hedge against inflation.

Cryptocurrencies such as Bitcoin have a limited supply, which supposedly protects them from devaluation compared to traditional fiat currencies. The argument goes that as the growth of the money supply overtakes the growth in the supply of Bitcoin, the price of Bitcoin will increase. Many other cryptocurrencies use a similar mechanism to cap supply, and this can act as a safeguard against inflation.

However, Bitcoin's price has been shown to be vulnerable to external influences. Large investors, known as "Bitcoin whales", can manipulate prices by buying or selling in large quantities, meaning that Bitcoin can be dictated by speculative forces, not solely the money-supply rule.

Another concern is that cryptocurrencies are still at the mercy of regulators and wildly varying laws across jurisdictions. Anti-competitive laws and short-sighted regulations could significantly hamper the adoption of the underlying technology, potentially depreciating the asset's price further.

Some investors, such as billionaire Wall Street investor Paul Tudor Jones, view Bitcoin as a better hedge against inflation than gold. However, other investors disagree. For example, investment ratings firm Morningstar concluded that "the assertion that [cryptocurrency] hedges against inflation rests on scanty evidence". Bank of America also found that "Bitcoin has not been compelling as an inflation hedge as commodities and even equities provide better correlations to inflation".

While some people view cryptocurrencies as a hedge against inflation, this view is disputed. Cryptocurrencies such as Bitcoin have a limited supply, which supposedly protects their value. However, Bitcoin's price is vulnerable to external influences, and it is still unclear how governments will regulate cryptocurrencies.

Blockchain technology

Blockchain is a type of shared database that differs from a typical database in how it stores information. Blockchain stores data in blocks that are linked together via cryptography. Each "block" contains data, and the blocks are linked in a chronological "chain". Once a block is added to the end of the blockchain, previous blocks cannot be altered. This makes blockchain data irreversible and tamper-proof.

Benefits of Blockchain

• Improved accuracy: By removing human involvement in verification, blockchain reduces errors.
• Cost reductions: Blockchain eliminates the need for third-party verification, reducing costs.
• Decentralisation: Blockchain is harder to tamper with as it is spread out among several network nodes.
• Secure, private and efficient transactions: Blockchain transactions are secure, private, and efficient, with built-in mechanisms to prevent unauthorised entries.
• Transparency: Blockchain is a transparent and open system, which helps to reduce corruption.

Drawbacks of Blockchain

• Speed and data inefficiency: Blockchain has a low number of transactions per second, and each block can only hold so much data.
• History of illicit use: Blockchain's confidentiality protects users from hacks but also allows for illegal trading and activity.
• Regulation uncertainty: Public perception of blockchain remains uneasy due to high-profile collapses of cryptocurrency brokers and the persistence of crypto scams.
• Data storage requirements: As blockchain use grows, so will the need for data storage, requiring more advanced techniques and more physical space.

Blockchain Use Cases

• Energy trading: Blockchain-based energy companies have created a trading platform for individuals to buy and sell electricity.
• Financial services: Traditional financial systems like banks and stock exchanges use blockchain to manage online payments, accounts, and market trading.
• Media and entertainment: Companies in media and entertainment use blockchain to efficiently manage copyright data and improve productivity.
• Retail: Amazon has filed a patent for a distributed ledger technology system that will use blockchain to verify the authenticity of goods sold on its platform.
• Voting: Blockchain could be used to create a modern voting system that eliminates election fraud and boosts voter turnout.

Frequently asked questions