Cryptocurrency: A Valid Investment Option?

Cryptocurrency is a digital currency that uses cryptography to secure transactions. It is a peer-to-peer system that enables anyone, anywhere, to send and receive payments without the need for banks to verify transactions. The first cryptocurrency, Bitcoin, was founded in 2009 and remains the most well-known and commonly traded.

Cryptocurrency can be a valid investment, but it is a risky one. It can provide high returns, but there is also a considerable downside. The market is extremely volatile, and investors need to be prepared for dramatic swings and potential losses. There are also security concerns, with cryptocurrency exchanges frequently targeted by hackers.

For those who want to invest, it is important to do your research, understand your risk tolerance, and decide how much of your investment portfolio can be allocated to cryptocurrencies.

Cryptocurrency as a new asset class

Cryptocurrency is a digital or virtual currency that uses cryptography to secure transactions. It is a decentralised system that does not rely on banks to verify transactions. Cryptocurrencies are generally used to pay for services or as speculative investments.

The decentralised structure of cryptocurrencies means they exist outside the control of governments and central authorities. This makes them theoretically immune to government interference or manipulation.

Cryptocurrency is a relatively new asset class, and as such, it is highly speculative. It can be a great investment with astronomically high returns, but there is also a considerable downside.

Pros

• Cryptocurrency can provide high returns overnight.
• As cryptocurrencies mature, we see the emergence of a new asset class. Institutional investors create dedicated investment funds that solely invest in Bitcoin and other cryptos, diversifying their risks.
• Cryptocurrencies can provide positive diversification effects, especially against rising inflation.
• The sector is quite new, and there may be more changes that make investing in cryptocurrencies even more attractive. For example, stablecoins are cryptocurrencies linked to the value of a fiat currency, backed by assets.
• Cryptocurrencies are usually built using blockchain technology, which is hard for hackers to tamper with.
• Transactions require a two-factor authentication process, providing security and safety.

Cons

• Cryptocurrency exchanges are vulnerable to being hacked and becoming targets of other criminal activity, leading to significant losses for investors.
• Safely storing cryptocurrencies is more difficult than owning stocks or bonds. Many people don't like keeping their digital assets on exchanges as it gives the exchange control over their assets.
• Storing cryptocurrency on a centralised exchange means you don't have full control over your assets. An exchange could freeze your assets or go bankrupt.
• Some cryptocurrency owners prefer offline "cold storage" options such as hardware wallets, but there is a risk of losing your private key and being unable to access your cryptocurrency.
• There is no guarantee that a crypto project you invest in will succeed due to fierce competition among thousands of blockchain projects, and many projects are scams.
• Regulators may crack down on the crypto industry if governments view cryptocurrencies as a threat.
• The cutting-edge technology elements of cryptocurrency also increase risks for investors as much of the tech is still being developed and not yet extensively proven.
• The value of virtual currencies is driven entirely by supply and demand, creating wild swings that produce significant gains or big losses for investors.
• Cryptocurrency investments are subject to less regulatory protection than traditional financial products.

Risks of investing in cryptocurrency

Investing in cryptocurrencies comes with a unique set of risks that investors should be aware of. Here are some of the critical risks associated with investing in cryptocurrencies:

Volatility and Manipulation:

Cryptocurrency prices are highly volatile and susceptible to sharp and sudden moves due to changes in market sentiment. This volatility is fuelled by speculation, sentiment, and potential market manipulation by influential investors, media owners, and crypto exchanges. The unregulated and anonymous nature of digital asset markets further contributes to price volatility.

Security and Custody:

Storing cryptocurrencies securely is a significant challenge. Cryptocurrency exchanges and personal wallets are vulnerable to hacking, and investors may lose their assets with little recourse for recovery. Additionally, the loss or destruction of private keys can result in the inability to access digital assets.

Regulatory and Tax Risks:

The regulatory landscape surrounding cryptocurrencies is complex and evolving. The lack of clear regulatory frameworks creates uncertainty for investors, and a sudden regulatory crackdown could negatively impact the market. Additionally, the tax treatment of cryptocurrencies varies across jurisdictions, and investors may face unexpected tax liabilities.

Counterparty and Management Risks:

Many investors rely on exchanges or custodians to store their cryptocurrency. In such cases, theft, loss, or unethical management practices by these third parties could result in the loss of the entire investment.

Technical and Programming Risks:

The technical complexity of using and storing crypto assets can be a challenge, especially for new users. Additionally, the use of automated smart contracts on investment platforms may expose investors to the risk of bugs or exploits, potentially leading to the loss of their investment.

Adoption and Acceptance:

Cryptocurrencies face low market adoption due to regulatory concerns, technology shortfalls, public misunderstandings, and the emerging nature of the technology. There is a chance that this asset class may never gain broad acceptance, leading to a complete loss of value.

These risks highlight the speculative nature of cryptocurrency investments and the importance of conducting thorough research and understanding the associated risks before investing.

Pros of investing in cryptocurrency

Cryptocurrency has become a popular investment option, with its value increasing daily. Here are some pros of investing in cryptocurrency:

Minimal Transaction Costs:

Sending money online through traditional bank transfers can be time-consuming and expensive. Cryptocurrency transactions, on the other hand, typically have little to no transaction fees due to the negligible commissions involved.

24/7 Access to Money:

Unlike share markets or bank accounts, which operate within specific timelines, cryptocurrencies provide investors with constant access to their funds. This allows for transactions to be made at any time without being restricted by traditional banking hours.

Fast and Secure Transactions:

Cryptocurrency transactions are usually faster than traditional bank transfers, especially for international transfers. Blockchain technology can process transactions within seconds in a secure manner. Additionally, the use of blockchain technology and cryptography ensures that cryptocurrency transactions are relatively secure and less susceptible to fraudulent activities.

Protection from Inflation:

Inflation has caused the value of many traditional currencies to decline over time. In contrast, most cryptocurrencies have a fixed total supply, as specified in their source code. For example, there will only ever be 21 million Bitcoins in circulation. As demand increases, the limited supply of cryptocurrencies means their value will increase, which can help maintain purchasing power in the long run and prevent inflation.

Decentralization and Self-Regulation:

Cryptocurrencies are decentralized, meaning they are not controlled by any central authority, government, or organization. This keeps the currency stable and secure, as no single entity can manipulate its flow or value. Additionally, the governance and maintenance of cryptocurrencies are handled by developers and miners, who have a vested interest in maintaining accurate and up-to-date transaction records, further ensuring the integrity of the cryptocurrency.

Enhanced Privacy:

Cryptocurrency transactions offer a level of privacy as they are pseudonymous. While transactions are recorded on a public blockchain ledger, they are linked to wallet addresses rather than specific user identities. This adds a layer of anonymity, making it harder to connect transactions to a particular individual.

Diversification:

Investing in cryptocurrencies can provide diversification benefits to an investment portfolio. Cryptocurrencies are considered a non-correlated asset class, meaning their price movements are largely independent of stocks, bonds, and commodities. As a result, investing in cryptocurrencies can help reduce overall portfolio risk and potentially enhance returns.

How to buy cryptocurrency

Cryptocurrency is a digital or virtual currency secured by cryptography, which makes it nearly impossible to counterfeit or double-spend. It is decentralised, meaning it is not issued, backed, or regulated by a central authority like a government.

If you want to invest in cryptocurrency, here is a step-by-step guide:

• Choose what cryptocurrency to invest in: There are thousands of cryptocurrencies to choose from, including Bitcoin, Ethereum, Cardano, XRP, Solana, and Dogecoin. You may choose to invest in one or several different cryptocurrencies.
• Choose a reputable cryptocurrency exchange: Examples include Coinbase, Gemini, and Kraken. When selecting an exchange, consider factors such as security, fees, trading volume, minimum investment requirements, and the types of cryptocurrency available.
• Explore storage and digital wallet options: You can keep your cryptocurrency on the same platform where you invest, or you can use a digital wallet. A "hot" wallet is accessible via the internet and is generally more convenient, while a "cold" wallet is a physical storage device that keeps your cryptocurrency keys completely offline and is more secure.
• Decide how much to invest: This will depend on factors such as your budget, risk tolerance, and investing strategy. Remember to only invest what you can afford to lose.
• Manage your investments: Cryptocurrency can be used to buy things or held as a long-term investment. How you manage your crypto holdings depends on your investing strategy and goals.

It is important to note that investing in cryptocurrency is risky, and the market is highly volatile. There are also regulatory and security concerns to keep in mind.

How to store cryptocurrency

There are several ways to store cryptocurrency, each with its own pros and cons. Here are some of the most common methods:

Hardware Wallets

Hardware wallets are physical devices that store your private keys offline. They are considered one of the safest options for storing cryptocurrency, as they are not connected to the internet and therefore cannot be hacked. Some popular options include the Ledger Nano X and Trezor Model T, which are typically USB drives that connect to your device. These wallets usually come with software that works in parallel to your device, allowing you to view and use your holdings without entering your private keys. However, they can be inconvenient and require an additional cost to purchase.

Custodial Wallets

Custodial wallets are managed by a third party, such as a cryptocurrency exchange like Coinbase. In this arrangement, the custodian stores your private keys and may provide insurance for your holdings. They are convenient and easy to use, especially for new crypto traders. However, they are not as secure as hardware wallets since you are relying on the security measures of the third party. Additionally, there is a risk of the exchange being hacked or going bankrupt.

Hot Wallets

Hot wallets are applications that store cryptocurrencies online. They are typically available as desktop or mobile apps, or web-based. Hot wallets give you control over your crypto and are usually free and easy to use. They also come with a recovery phrase that allows you to access your crypto if you lose your device. However, the major downside is the risk of being hacked since they are connected to the internet.

Cold Wallets

Cold wallets are offline crypto wallets and are considered the most secure option for storing large amounts of cryptocurrency. There are different types of cold wallets, including hardware wallets and paper wallets. Paper wallets are a simple and free way to store your private keys offline, but they are less user-friendly and may be more prone to loss or theft.

Multi-Signature Wallets

Multi-signature wallets require transaction approval from multiple people, adding an extra layer of security. This limits the threat of theft as a single controller cannot carry out transactions. However, it is important to know and trust the other people involved in the wallet.

Frequently asked questions