Crypto: A Risky Bet Or A Wise Investment?

Investing in cryptocurrencies has become increasingly popular, but it is not without its risks. Crypto is a highly volatile asset, and investors need to understand that owning it involves taking on a great deal of risk. Some of the dangers of investing in crypto include its volatility, unproven rate of return, fraud, and hacks. Additionally, cryptocurrencies are not backed by tangible assets or governments, and they are prone to hoarding. For these reasons, crypto may not be a good investment for those looking to grow their retirement portfolios or place their savings for growth. However, for investors who understand how to manage risk, crypto could present great opportunities.

No cash flow generated

One of the main reasons why some investors consider cryptocurrencies a bad investment is that they do not generate cash flow. Traditional investors typically view investments as cash outflows that will generate future cash inflows without needing to sell the asset. For example, if someone buys a house, they can rent it out and generate a cash flow without selling the property. Similarly, equity shares in a business generate cash flow in the form of dividends.

However, cryptocurrencies do not generate any cash flow. The only way for an investor to make money is to find someone willing to pay a higher price for the currency, making investors vulnerable to market fluctuations. This lack of periodic cash flows makes cryptocurrencies speculative, with most holders being short-term speculators hoping for a quick profit.

This dynamic is often referred to as the "greater fool theory", where the only way to profit is to convince someone else to buy the same asset at a higher price. As a result, cryptocurrencies are seen by many traditional investors as a risky and speculative investment rather than a stable, long-term investment.

Not backed by tangible assets

Cryptocurrencies are not backed by tangible assets, unlike traditional currencies. For instance, the value of the US dollar is tied to the power of the government, and gold and silver are considered valuable because they are precious metals. Cryptocurrencies, on the other hand, are not tied to promises made by a government or central bank, nor are they backed by physical assets in a vault. Instead, their value is derived from their scarcity and their utility as a mode of payment.

Bitcoin, for example, has a fixed cap of 21 million digital coins, and its blockchain technology ensures that it remains limited in supply and resistant to censorship. Additionally, thousands of merchants now accept Bitcoin as a form of payment, and it has been adopted as legal tender in El Salvador and the Central African Republic.

However, the lack of backing by tangible assets or government decree makes the value of cryptocurrencies highly speculative. There is no guarantee that their value will increase, and they are subject to extreme volatility. For instance, the price of one Bitcoin surged to over $60,000 in 2024, only to fall to half that value in just a few weeks.

The inherent instability of cryptocurrencies is further exacerbated by their susceptibility to market influences, such as tweets by Elon Musk, and their potential use in illicit activities, such as ransomware attacks.

While some stablecoins, a special type of cryptocurrency, are backed by tangible assets like gold and silver, the majority of cryptocurrencies are not. This lack of backing by tangible assets is a significant factor in the perception of cryptocurrencies as a risky and speculative investment.

Prone to hoarding

One of the arguments against cryptocurrencies like Bitcoin is that they are prone to hoarding. Cryptocurrencies are meant to be a medium of exchange, facilitating the transaction of goods and services. However, investors often hoard large amounts, believing their value will increase over time. This goes against the very nature of currency, which is meant to stay in circulation.

Hoarding can be understood as a form of saving or delayed gratification. An individual who hoards cryptocurrency is making a choice to wait for a better option, either to ensure future well-being or because they are waiting for something better to come along. This is not necessarily a negative thing, as it can be compared to investing in land or other commodities. The problem arises when the cryptocurrency is not used at all, which goes against the fundamental purpose of a currency.

Some governments have seized large amounts of Bitcoin through criminal investigations and auctions, indicating that they may be collecting and hoarding it. For example, the Bulgarian government seized more than 200,000 bitcoins in 2017, and North Korea has been linked to hacks or attempted hacks of digital currency exchanges, with speculation that they are trying to prop up the price of Bitcoin.

The wealthy are also hoarding Bitcoin, keeping it safe in underground vaults spread over different continents. This further reduces the amount of cryptocurrency in circulation, which can impact its value.

The argument against hoarding is that it can slow down the economy, as less currency is being spent. However, others argue that this is a subjective judgement and that individuals have the right to choose how they spend their money. It is also important to note that the value of Bitcoin and other cryptocurrencies is based on demand, so hoarding can also be seen as a way to increase the purchasing power of each unit.

Volatile and unpredictable

Cryptocurrency is a highly volatile and unpredictable asset class. Its value can fluctuate wildly in a short space of time, making it a risky investment. For example, in just a few weeks, Bitcoin's value halved from over $60,000 to around $30,000. Other cryptocurrencies, such as Dogecoin, have seen even more dramatic rises and falls, often based on little more than Elon Musk's tweets.

The extreme volatility of cryptocurrencies is due to their lack of intrinsic value and the fact that they are not backed by tangible assets or government decree. Unlike traditional currencies, which fluctuate based on economic factors, crypto values seem to change randomly, making it impossible for investors to predict or track fundamentals.

The unpredictable nature of crypto means that investors are highly vulnerable to the whims of the marketplace. The only way to make money is to find someone willing to pay a higher price for the currency, which is inherently speculative. This is why many orthodox investors, like Warren Buffet, refuse to invest in cryptocurrencies.

The instability of cryptocurrencies is further exacerbated by their susceptibility to fraud and hacks. In the first three months of 2023, hackers stole $400 million worth of crypto, and in 2021, over $3.2 billion was stolen. Crypto exchanges and wallets are also vulnerable to hacks, with millions of dollars in coins often being stolen.

The extreme volatility and unpredictability of cryptocurrencies make them a very risky investment. Investors can lose significant sums of money very quickly, and there is no guarantee that values will rise again. As such, crypto is best suited to experienced investors who understand how to manage risk and are prepared to lose their entire investment.

Susceptible to fraud and theft

Cryptocurrencies are susceptible to fraud and theft. The decentralised nature of cryptocurrencies means that they are not backed by governments or central banks, and transactions are irreversible. This makes them an attractive target for scammers.

Scammers often impersonate legitimate businesses or government agencies and demand payment in cryptocurrency. They may also pose as a romantic interest or a friend to gain your trust and convince you to invest in a fraudulent scheme. These scams are often referred to as "pig butchering scams". Scammers may also send emails with malicious links to a fake website to gather your personal details, such as cryptocurrency wallet key information. This is known as a phishing scam.

To avoid falling victim to these scams, it is important to do your research before investing in any cryptocurrency scheme and never click on suspicious links or provide your personal information to unverified sources.

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