Crypto Currency: Smart Investment Or Risky Gamble?

Investing in cryptocurrency is a hotly debated topic. On the one hand, it can provide astronomically high returns overnight, but it is also a very volatile and risky investment option. Cryptocurrency is a digital payment system that doesn't rely on banks to verify transactions. It is a peer-to-peer system that enables anyone, anywhere, to send and receive payments. The first cryptocurrency, Bitcoin, was founded in 2009 and remains the most well-known and commonly traded.

Cryptocurrency is a good investment if you want direct exposure to the demand for digital currency. However, it is important to note that cryptocurrency exchanges are vulnerable to being hacked and becoming targets of other criminal activity, and there is no guarantee that a crypto project you invest in will succeed.

Before investing in cryptocurrency, it is crucial to conduct thorough research and due diligence, understand your risk tolerance and financial goals, and decide how much of your investment portfolio can be allocated to cryptocurrencies.

The pros and cons of cryptocurrency

Pros

• Protection from inflation: Cryptocurrencies like Bitcoin have a capped supply, meaning there's a maximum number of coins that can ever exist. This scarcity can create a hedge against inflation, as the value is not diluted by an ever-increasing supply, unlike traditional fiat currencies.
• Speed of transactions: Cryptocurrencies can process transactions in minutes or even seconds, enabling immediate global transfers without the need for intermediaries or prolonged waiting periods.
• Cost-effective transactions: Cryptocurrencies offer a decentralised platform, eliminating the need for middlemen and reducing transaction costs, making them more affordable for individuals and businesses.
• Decentralisation: No single entity, like a government or central bank, has control over the entire network. Instead, control is distributed among multiple participants or nodes, ensuring no single point of failure exists and enhancing the security and resilience of the system.
• Safety and security: Cryptocurrencies offer high levels of security, utilising advanced cryptographic techniques. The underlying blockchain technology ensures that once a transaction is recorded, it cannot be altered, providing a permanent and tamper-proof record.
• Effortless currency exchange: Cryptocurrency exchange can be notably streamlined, allowing users to effortlessly exchange various cryptocurrencies or convert them into fiat currencies in real-time and from anywhere in the world with just a few clicks.

Cons

• Pseudonymous transactions: While providing a level of privacy and anonymity, all transactions are still recorded on the public blockchain, which can be associated with concerns regarding the potential misuse of illicit activities.
• Constant risk of an attack: No system is entirely immune to cyberattacks, and the threat is perpetual. Cyberattacks can lead to the theft of assets, loss of personal information, or a compromised network.
• Excessive power consumption: Certain mining processes, notably Bitcoin, require a significant amount of energy, which has raised environmental concerns.
• Lack of key policies: The absence of standardised regulations and guidelines that govern the usage and trading of digital currencies creates uncertainty and inconsistency, posing challenges for investors, users, and authorities.
• Costly network participation: The significant investment required to become a miner or operate a full node within certain blockchain networks can deter individual participation and lead to the centralisation of mining power in the hands of a few large entities.

The risks of investing in crypto

Investing in cryptocurrencies is risky due to the market's volatility, lack of regulation, and susceptibility to hacking.

Volatility

Crypto prices are extremely volatile, with sharp and sudden moves in price. This makes it difficult for investors to build confidence and secure gains. Volatility in crypto prices stems from market sentiment, speculation, and manipulation. Crypto exchanges, media owners, and influential investors can manipulate prices, and there is also the risk of scams.

Lack of Regulation

Cryptocurrencies are currently unregulated by governments and central banks, which creates uncertainty for investors. There is also a lack of clarity around the tax treatment of cryptocurrencies, with substantial inconsistencies among various regulators.

Susceptibility to Hacking

Storing cryptocurrencies is risky due to the constant threat of hacking. Investors cannot recover assets that get lost or stolen, and mistaken transactions cannot be reversed. Many cryptocurrency exchanges and wallets have been hacked over the years, resulting in the theft of millions of dollars in coins.

Other Risks

Other risks of investing in cryptocurrencies include:

• Loss or destruction of the private key, which could result in an investor losing access to their digital wallet and bitcoins.
• Cyber-security risks, including malicious activity such as hacking or phishing attacks.
• Risks associated with peer-to-peer transactions, such as double-selling.
• Loss of confidence in digital currencies, which could lead to a collapse of trading activities and an abrupt drop in value.
• Currency-conversion risks, such as interruptions in the deposit or withdrawal of fiat currency.
• Slow-down of the network due to a high volume of transactions.
• Dilution due to competition or a "fork" in the blockchain, which can lead to the creation of separate networks and cryptocurrencies.

The future of crypto as a global currency

The future of cryptocurrency is uncertain, but its popularity is undeniable. The number of cryptocurrency investors has been steadily increasing worldwide, with analysts estimating that the global cryptocurrency market will more than triple by 2030, reaching a valuation of nearly $5 billion. Cryptocurrency has evolved from a relatively fringe community of anti-establishment investors to a household name. This evolution has also changed the power structure of the market, with massive corporate investments casting doubt on how democratic the market is.

The future of cryptocurrency is shaped by regulators, brands, and investors. While some governments have taken a hands-off approach, others have embraced or banned cryptocurrencies. The challenge for regulators is to develop rules that limit financial risks without stifling innovation. In the US, for example, the Securities and Exchange Commission (SEC) has approved the first set of exchange-traded funds (ETFs) that include Bitcoin, granting it entry into the traditional securities market. However, the lack of a global framework for crypto regulation remains an issue, with international views ranging from recognising Bitcoin as an official currency to banning crypto transactions altogether.

The institutional money pouring into cryptocurrency is changing the market. Cryptocurrency recruited users who wanted to shake up the exclusive world of finance and create a widely accessible way to move money. However, the mining network has been ring-fenced by a few companies that can provide the computing power and electricity required to mine at scale, making it difficult for independent users to get involved. This has led to concerns about the market's democracy, especially with massive corporate investments causing price jumps.

Despite the risks and uncertainties, cryptocurrency could be the future of money. It offers faster and cheaper money transfers, removes single points of failure, and eliminates the need for third-party intermediaries. Additionally, stablecoins, which are cryptocurrencies linked to the value of a fiat currency, could be more effective as a form of payment due to their stable value.

However, there are also drawbacks and risks associated with cryptocurrency. It suffers from price volatility, high energy consumption for mining, and use in criminal activities. The lack of coherent regulations also means there are few protections against deceptive management practices, smart contract bugs, and market manipulation.

In conclusion, the future of cryptocurrency as a global currency is uncertain. While it offers benefits such as faster and cheaper transactions, it also faces challenges related to regulation, energy consumption, and criminal activities. The balance between regulating a lawless commodity and allowing it to build value will be crucial for its future.

Crypto as a hedge against inflation

The traditional definition of an inflation hedge states that if consumer prices are increasing, the price of Bitcoin should also rise, making it a good hedge. However, this relationship has not always held, with Bitcoin's price falling even during high inflation. This can be attributed to various factors, including the war in Ukraine, Federal Reserve's interest rate hikes, and the unpredictable nature of investor sentiment.

Despite this, some believe that Bitcoin is still a good hedge against inflation over longer time horizons. Its trailing five-year return of 1,100% during a period of 18.5% CPI increase supports this view. Additionally, Bitcoin's lack of central governance and finite supply make it inherently resistant to inflationary pressures caused by central bank policies.

However, critics argue that Bitcoin's high volatility and correlation with monetary policy changes make it unreliable as an inflation hedge. The increase in interest rates to combat inflation has negatively impacted Bitcoin's price, and its fixed supply limits its ability to adjust to changing demand.

In conclusion, while crypto, specifically Bitcoin, has the potential to be a hedge against inflation due to its finite supply and accessibility, it is not yet a reliable hedge. Its high volatility and sensitivity to interest rate changes make it susceptible to market forces. For crypto to become a stable hedge, it needs to achieve mass adoption and establish its fundamentals, addressing the current technical challenges and improving its stability.

Crypto taxes

In India, foreign crypto exchanges are subject to Goods and Services Tax (GST). The Indian government has been pursuing exchanges such as Kraken and Bitfinex for unpaid GST, and has banned them from operating in the country until they pay the tax owed.

Other countries have different approaches to crypto taxes. For example, in El Salvador, Bitcoin is legal tender and so is likely treated as regular currency for tax purposes. In China, cryptocurrency exchanges, transactions, and mining are banned, so no taxes are levied on them.

Frequently asked questions