Bitcoin: Risky Business Or Safe Bet?

Bitcoin is a risky investment. Its price is volatile and unpredictable, and it is susceptible to cyberattacks and fraud. The market is also unregulated, and there is little protection for investors if a crypto exchange fails. However, it is becoming more integrated with traditional financial markets and is seeing significant participation from retail and institutional investors.

Bitcoin's volatile market

Bitcoins Volatile Market

Bitcoin is a cryptocurrency, a virtual currency, that was introduced to the public in 2009 by an anonymous developer or group of developers using the name Satoshi Nakamoto. It has since become the most well-known and largest cryptocurrency in the world. Its popularity has inspired the development of many other cryptocurrencies.

Bitcoin's value is constantly changing. For example, on November 6, 2018, one bitcoin was worth $6,461.01. If you purchased a bitcoin on December 17, 2017, the price topped $20,000. Days later, on the 24th, buyers could not sell their investment for more than $14,626. The bitcoin market is constantly fluctuating. With such an unpredictable market, there’s no telling if you will get a return on your investment.

The price of bitcoin tends to follow stock market trends because bitcoin is treated the same way that investors treat other investments. However, bitcoin price movements are greatly exaggerated and sometimes are prone to movements of thousands of dollars. Many bitcoin investors tend to "trade the news," as demonstrated by the fluctuations that occur whenever there is a significant news event.

Bitcoin's all-time high price is $73,794, reached on March 14, 2024.

Risks of Investing in Bitcoin

As a result of such price movements, many people purchase bitcoin for its investment value rather than its ability to act as a medium of exchange. However, the lack of guaranteed value and its digital nature mean its purchase and use carry several inherent risks.

Bitcoin is not considered a security by the authorities, but that stance could change in the future. Most individuals who own and use bitcoin do not acquire their tokens through mining operations. Rather, they buy and sell bitcoin and other digital currencies on popular cryptocurrency exchanges. These exchanges are entirely digital and are at risk from hackers, malware, and operational glitches.

Bitcoin and other cryptocurrencies are not insured by the Securities Investor Protection Corporation (SIPC) or the Federal Deposit Insurance Corporation (FDIC). However, some exchanges provide insurance through third parties. For instance, Gemini and Coinbase offer cryptocurrency insurance, but only for failures in their systems or cybersecurity breaches.

Even with the security measures inherent within a blockchain, there are still opportunities for fraudulent activity. As with any investment, bitcoin values can fluctuate. Indeed, the currency's value has seen wild price swings over its short existence. Subject to high-volume buying and selling on exchanges, it is highly sensitive to any newsworthy events.

Susceptibility to cyberattacks

Bitcoin's underlying blockchain technology was initially believed to be essentially unhackable. However, this has proven not to be the case, with several high-profile cyberattacks on Bitcoin and other cryptocurrency blockchains occurring over the years. In the period between 2011 and 2021, approximately 1.7 million units of Bitcoin were stolen in cyberattacks, with losses exceeding $700 million.

There are several reasons why hackers have been able to breach blockchains. Some of these are related to the technology itself, while others are due to external factors.

Weak Smart Contracts

Smart contracts are code that automatically executes transactions when certain conditions are met. As with any code, smart contracts often contain vulnerabilities that allow hackers to exploit them for their own gain. Securing smart contracts is a challenging task, even for experienced programmers and security professionals.

51% Attacks

Since cryptocurrencies rely on consensus mechanisms (proof-of-work and proof-of-stake) for transaction validation, they are vulnerable to 51% attacks. In such an attack, malicious actors gain control of the majority of the computational power or available currency for a blockchain, allowing them to create and modify transactions. While it is unlikely that any individual or group could execute a 51% attack on Bitcoin, smaller cryptocurrencies are more susceptible. For example, Ethereum has suffered a successful 51% attack.

Investor Scams

The unregulated nature of the cryptocurrency market makes it susceptible to scams. Investors, eager to get in on the ground floor of the next big cryptocurrency, often fall prey to fraudulent investment schemes. These scams promise outrageous returns, sometimes more than 100,000% per year, but are nothing more than Ponzi or "pump-and-dump" schemes.

Phishing Scams

Phishing scams are another common method used by hackers to target cryptocurrency investors. These scams often involve posing as legitimate cryptocurrency companies or platforms to trick investors into providing sensitive information or downloading malware. For example, in 2015, a phishing attack on the Bitcoin exchange Bitstamp resulted in the theft of about $5 million.

Software Vulnerabilities

The blockchain field is still in its infancy, and as a result, there are few laws and regulations governing cryptocurrency exchanges. This lack of regulatory oversight creates vulnerabilities that hackers can exploit to steal significant amounts of money.

The Impact of Cyberattacks on Bitcoin

The frequent cyberattacks on cryptocurrency exchanges and the resulting losses have undermined trust in Bitcoin and other cryptocurrencies. This has slowed their development and acceptance as a legitimate form of currency. Additionally, the lack of consumer protection and the difficulty of recovering lost funds make Bitcoin a risky investment, particularly for those unfamiliar with the technology.

Mitigating the Risk of Cyberattacks

To protect against cyberattacks, cryptocurrency exchanges need to implement comprehensive procedures for identifying and addressing information security vulnerabilities. The use of multisignature private keys, for example, can help prevent hot wallet attacks. Additionally, improving security measures for employee login credentials and regularly updating software to patch vulnerabilities can reduce the risk of breaches.

While it is impossible to eliminate the risk of cyberattacks entirely, implementing robust security measures can help to mitigate the impact of these attacks and protect investors' funds.

Lack of regulation

Bitcoin and other cryptocurrencies are a new phenomenon, and central banks and governments are still unsure how to react to the implications of this technology. The lack of regulation around bitcoin is a significant risk for investors.

Currently, the bitcoin market is operating without any major regulations. The market is too new for governments to have a clear stance on it, and there is no taxation on bitcoin. This lack of taxation could lead to problems if bitcoin becomes competition for government currency. While it is not a widely accepted currency, the future is ever-changing, and the state of the bitcoin market could look very different in a few years.

The US Federal Government, for example, has not claimed the right to regulate cryptocurrencies exclusively, leaving individual states to determine how their citizens can participate. The only concrete statements made about cryptocurrency from federal entities concern how people must report their profits (capital gains to the IRS) and how they are taxed (as property).

In contrast, other countries have embraced cryptocurrency in a non-regulatory manner. Switzerland, for instance, has stated that while there is no need to regulate cryptocurrency currently, laws on how the financial sector will make use of them are being established to determine their status as securities and taxability.

In Germany, bitcoin is considered a "unit of account", and its citizens are free to trade it as they wish. However, it is also taxable and must incur VAT when traded with Euros. Germany has also recognised the danger of some cryptocurrency concepts like ICOs and has issued warnings about "risky, highly speculative forms of investment" and the potential for fraud.

Asia's stance on bitcoin and cryptocurrencies varies. Japan is arguably the most cryptocurrency-positive country and has recognised coins like bitcoin as a "legal means of payment", but not as a traditional currency. This means that banks cannot offer bitcoin to customers, but it is not unlawful to hold bitcoins, leaving the sector to be driven by fintech innovators exclusively.

Other territories in Asia view the onset of cryptocurrency with fear. In countries like Bangladesh, Nepal, and Kyrgyzstan, using or trading virtual currencies is highly illegal and comes with harsh punishments. China also has a rocky history with cryptocurrency. The lack of any regulation helped China become an early adopter, especially in bitcoin trading and mining, but scared by how much capital was fleeing the country via bitcoin, China imposed strict regulations, and enthusiasts in the country are still dealing with the consequences.

Technology reliance

Bitcoin is a technology-reliant online exchange. Coins are digitally mined, exchanged via smart wallets, and kept in check using various systems. Without the technology, cryptocurrency is worthless. Unlike other forms of currency or investment, there is no physical collateral to back it up.

Bitcoin is a completely technology-based currency. It is mined, exchanged, and stored digitally. This means that bitcoin owners are more vulnerable to cyber threats, online fraud, and system shutdowns. As a result, bitcoin investors are exposed to hacking and fraud risks.

Bitcoin mining was initially possible on a personal computer. However, as it gained popularity, more miners joined the network, reducing the likelihood of solving a hash independently. Today, mining requires either joining a mining pool or purchasing an ASIC miner, which can cost around $10,000.

The blockchain technology that underpins Bitcoin is also vulnerable to technological risks. Blockchain interoperability empowers distinct blockchain networks to communicate, share data, and collaborate. This increases decentralization in the blockchain sector, ushering in a trustless user experience where reliance on centralized exchanges diminishes. However, this also creates new risks, such as quantum computing, artificial intelligence advancements, and environmental concerns.

Additionally, the lack of physical collateral backing Bitcoin means that investors can lose everything they invest. The volatile and fluctuating market makes it challenging to predict if an investment will yield a return.

To summarize, Bitcoin's technology reliance exposes investors to various risks, including cyber threats, online fraud, system failures, and market volatility.

Bitcoin's association with illegal activity

Bitcoin has been associated with illegal activity due to its anonymous, decentralised, and unregulated nature. This makes it an attractive option for criminal actors and terrorists. In 2018, a study by blockchain analysis startup Elliptic and the Center on Sanctions and Illicit Finance found a fivefold increase in large-scale illegal operations using the Bitcoin blockchain between 2013 and 2016. The study identified 102 criminal entities, including dark web marketplaces, Ponzi schemes, and ransomware/malware attackers.

The anonymous nature of Bitcoin transactions is a key attraction for criminals. While transactions are recorded on a public blockchain, the identities of those making the transactions remain unknown. This allows criminals to trade drugs, weapons, explosives, and child pornography, as well as fund extremist organisations, without revealing their identities.

The lack of regulation and the absence of a central authority also mean that Bitcoin transactions are not subject to the same anti-money laundering regulations and governmental sanctions as traditional banks. This makes it easier for criminals to move and launder large sums of money internationally without attracting the attention of authorities.

The ease and speed of Bitcoin transactions further enable illegal activity. Cryptocurrencies can be transferred quickly and easily anywhere in the world, with no delays or need for validation by a central body. This makes it possible for criminals to steal and launder funds rapidly, as demonstrated by the 2020 hack of the KuCoin exchange, where $275 million in cryptocurrency was stolen by the Lazarus Group, a cybercrime organisation with ties to North Korea.

While Bitcoin has been associated with illegal activity, it is important to note that the majority of Bitcoin transactions are not criminal in nature. According to Chainalysis' 2021 report, criminal activity represented only 0.34% of all cryptocurrency activity in 2020, amounting to $10 billion in transaction volume. This is a decrease from 2019, where criminal activity accounted for 2.1% of cryptocurrency transactions.

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