Cryptocurrency Investment: Should You Take The Risk?

Investing in cryptocurrency is a hot topic. It can be a risky business, but it could also be a lucrative one. Cryptocurrencies are decentralised and secure digital money, based on blockchain technology. They are not regulated like stocks or insured like cash in banks. Crypto is extremely volatile, and investors need to understand that owning it involves taking on a great deal of risk. However, for investors who understand how to manage risk, crypto could present great opportunities.

Should I invest in crypto?

Investing in cryptocurrencies is risky due to the potential for high losses from security breaches. Crypto is not regulated like stocks or insured like money in banks. It is also subject to extreme volatility and regulatory uncertainty.

However, for investors who understand how to manage risk, crypto could present great opportunities. Cryptocurrencies are decentralised and secure digital money, based on blockchain technology, that offers new investment opportunities.

If you're thinking about investing in crypto, here are some things to consider:

• Only invest what you can afford to lose.
• Do your research and stick to the fundamentals and major cryptocurrencies.
• Understand the technology and the investment thesis for each coin.
• Be aware of the risks, including loss of capital, fraud, hacks, and regulatory changes.
• Consider the tax implications of investing in crypto.
• Diversify your portfolio and don't put all your eggs in the crypto basket.
• Consult with a financial advisor to get personalised advice.

How safe is cryptocurrency?

Cryptocurrency is a digital or virtual currency underpinned by cryptographic systems. It enables secure online payments without the use of third-party intermediaries. While it is a legitimate and legal investment option, there are some safety concerns.

User Risk

Unlike traditional finance, there is no way to reverse or cancel a cryptocurrency transaction after it has been sent. It is estimated that about one-fifth of all Bitcoins are now inaccessible due to lost passwords or incorrect sending addresses.

Regulatory Risks

The regulatory status of some cryptocurrencies is still unclear in many areas, with some governments seeking to regulate them as securities, currencies, or both. A sudden regulatory crackdown could make it challenging to sell cryptocurrencies or cause a market-wide price drop.

Counterparty Risks

Many investors and merchants rely on exchanges or other custodians to store their cryptocurrency. Theft or loss by one of these third parties could result in losing one's entire investment.

Management Risks

Due to the lack of coherent regulations, there are few protections against deceptive or unethical management practices. Many investors have lost large sums to management teams that failed to deliver a product.

Programming Risks

Many investment and lending platforms use automated smart contracts to control the movement of user deposits. An investor using one of these platforms assumes the risk that a bug or exploit in these programs could result in a loss of their investment.

Market Manipulation

Market manipulation remains a substantial problem in cryptocurrency, with influential people, organizations, and exchanges acting unethically.

Volatility

Cryptocurrency is also susceptible to price volatility, with rapid surges and crashes in value. For example, Bitcoin climbed to nearly $65,000 in November 2021 before dropping to just over $20,000 a year and a half later.

Criminal Activity

The pseudonymous nature of cryptocurrency transactions leaves a digital trail that agencies like the FBI can follow. This opens up the possibility for governments and authorities to track financial transactions, and cryptocurrencies have become a popular tool for criminals to launder money and make illicit purchases.

Security

While the underlying cryptography and blockchain are generally secure, the technical complexity of using and storing crypto assets can be a significant hazard for new users. Cryptocurrency exchanges and wallets can be hacked, and once cryptocurrency is stolen, it is often impossible to recover.

Best Practices for Staying Safe

To stay safe when investing in cryptocurrency, it is recommended to:

• Only keep your cryptocurrency on an exchange if you are actively trading it. Otherwise, transfer it to an external wallet.
• Use two-factor authentication (2FA) on your wallets and exchanges.
• Write down the seed words for your wallet on a piece of paper and store it safely.
• Use strong, unique passwords.
• Store your crypto in a hardware wallet if possible.
• Avoid phishing and fake software or websites.
• Don't enter your seed words on any website.
• Avoid public Wi-Fi, or use a virtual private network service if you must use public Wi-Fi.

Risks of investing in cryptocurrency

Investing in cryptocurrency is risky due to its volatile nature, lack of regulation, and susceptibility to hacking. Here are some key risks to consider:

Volatility and Manipulation

Cryptocurrency prices are highly volatile and subject to sharp, sudden moves due to unexpected changes in market sentiment. This volatility is influenced by sentiment, speculation, and potential market manipulation by crypto exchanges, media owners, and influential investors. The unregulated and anonymous nature of digital asset markets contributes to this volatility, making it challenging for investors to build confidence and secure gains.

Regulatory Uncertainty

The lack of clear regulatory frameworks creates uncertainty for investors. Cryptocurrencies are currently unregulated by governments and central banks, but this is evolving. The classification of cryptocurrencies as currency or financial assets has tax implications and can impact their legality in certain jurisdictions. Regulatory changes can significantly affect the value of cryptocurrencies or even lead to bans.

Cybersecurity Threats and Human Error

Cryptocurrency exchanges face constant cybersecurity threats, and there is a risk of hacking, technical glitches, and human error. Investors need to choose platforms with robust security measures and enable strong security protocols for their digital wallets. If private keys are lost, destroyed, or compromised, investors may lose access to their cryptocurrency holdings.

Limited Market Adoption and Institutionalization

Cryptocurrency markets are still in their infancy, and market adoption remains low due to regulatory concerns, technology shortfalls, public misunderstandings, and the emerging nature of the technology. There is a chance that this new asset class may never gain broad adoption, leading to a complete loss of value.

Consumer Rights and Recovery

Cryptocurrency investments do not have the same official safeguards or insurance as traditional investments through banks or brokerages. If assets are lost or stolen, investors cannot recover them, and mistaken transactions cannot be reversed. Rebates on lost investments depend on the organization's discretion.

Crypto adoption

However, crypto adoption still faces some challenges. One of the main barriers is the lack of technical literacy among potential users. The complexity of blockchain technology and its associated jargon can be intimidating and confusing for those without a technical background. This is evident from surveys conducted by Australian crypto exchange Swyftx and the 2023 Crypto Literacy Survey, where a significant number of respondents cited a lack of understanding as a reason for not entering the crypto space.

To address this issue, the cryptocurrency industry is taking steps to simplify educational resources and create user-friendly platforms. Alicia Kao, Managing Director of crypto exchange KuCoin, emphasised the need to strike a balance between maintaining the innovative essence of cryptocurrency and making it more approachable through simplified concepts, user-friendly interfaces, and comprehensive educational resources.

Another challenge to crypto adoption is the regulatory environment surrounding cryptocurrencies. The lack of clear and consistent regulations across different regions can create confusion and deter potential users. However, there have been some positive developments, such as the European Council adopting the first comprehensive legal framework for the crypto industry in May 2023.

Despite these challenges, crypto adoption continues to grow, driven by the increasing popularity of cryptocurrencies and blockchain technology. The introduction of spot Bitcoin exchange-traded funds (ETFs) has also contributed to a massive spike in crypto use.

Overall, the widespread adoption of cryptocurrency will depend on addressing the complexity concerns, navigating the regulatory landscape, and making crypto more accessible and intuitive for the average user.

Crypto as a long-term investment

Cryptocurrency is a highly volatile asset class that has seen tremendous highs and lows since the launch of Bitcoin in 2009. While it has delivered tremendous profits for some investors, others have lost significant sums. Due to its speculative nature, extreme volatility, and regulatory uncertainty, crypto is considered a high-risk asset class. However, for investors who understand how to manage risk, crypto could present great long-term investment opportunities.

Potential Benefits of Long-Term Crypto Investments

Build Wealth Over Time

Long-term crypto investments can be a good option for building wealth over time. The potential for high rewards is much greater compared to other types of capital investments. For example, just $1,000 in Bitcoin in 2010 would be worth over $200 million today.

Less Active Management

Long-term investing in crypto does not require the same level of active management as short-term trading. With long-term investments, there is no need to constantly monitor the market and try to time market tops and bottoms.

Tips for Long-Term Crypto Investing

Understand the Technology and Fundamentals

It is important to take the time to understand the underlying technology powering different crypto assets, such as blockchain networks, consensus mechanisms, hashing algorithms, and smart contracts. This knowledge will give you better insight into a project's prospects. Additionally, research the fundamentals of a crypto project, including real-world adoption potential, technical specifications, the founders and developers, community engagement, and competitors.

Stick to Major Cryptocurrencies

Large, established cryptocurrencies like Bitcoin and Ethereum have been running for longer, have larger market capitalizations, and have weathered several market cycles and downturns. They are also tied to a series of financial products, such as ETFs and derivatives markets. While risks remain, bigger cryptocurrencies have generally demonstrated more resilience than newer or smaller-cap coins.

Only Invest What You Can Afford to Lose

This is a crucial rule when investing in crypto or any other high-risk asset class. Only invest an amount of capital that you are fully prepared to lose if the market takes a downturn. It is recommended to have enough emergency savings before putting any funds into crypto and to limit crypto exposure to less than 5% of your total portfolio.

Use Dollar-Cost Averaging

Dollar-cost averaging involves making small, recurring purchases of crypto on a set schedule, such as weekly or monthly. This method helps to reduce the impact of volatility by buying relatively more crypto when prices drop and less when they rise. It also removes the psychology of trying to perfectly time the market.

Risks of Long-Term Crypto Investing

Loss of Capital

Due to its high volatility, crypto investments carry a significant risk of loss of capital. With Bitcoin, for example, experiencing a more than 60% decline over the past 12 months, these losses can easily add up to a significant portion of the original investment.

Regulatory Uncertainty

The crypto industry is still relatively new and unregulated, making it difficult to predict future government regulations and their impact on the industry. There is also a possibility that cryptocurrencies could be banned in certain countries, as has already happened in China.

Fraud and Hacks

Fraud and cybercrime are common in the crypto space due to a lack of regulatory oversight. In 2022, cryptocurrency fraud soared, and in 2021, more than $3.2 billion of cryptocurrency was stolen. If you lose your crypto in a hack, you may have no recourse for getting back your investment.

Crypto can be a good long-term investment for those who understand how to manage risk and are willing to do their due diligence. It offers the potential for high rewards and can help increase the diversification of an investment portfolio. However, it is crucial to approach crypto investing with caution, stay objective, and consider the risks relative to your overall financial situation.

Frequently asked questions