Cryptocurrency Investment: Wise Choice Or Risky Move?

Investing in cryptocurrency has become an increasingly popular topic of discussion, but is it a good idea? Cryptocurrency is a digital currency that exists on decentralised blockchain technology. It is a high-risk, volatile and largely unregulated investment. The value of cryptocurrencies can fluctuate massively in a short space of time, and there is always the possibility of losing everything invested. However, some people choose to invest in crypto for a variety of reasons, including the potential for high returns, portfolio diversification and as a hedge against inflation.

Crypto's high volatility and risk

Cryptos High Volatility and Risk

Cryptocurrency is a high-risk investment due to its extreme volatility. Crypto prices can fluctuate at extreme levels, often based on market speculation, and investors must be prepared to lose what they put in.

Volatility

Volatility refers to changes in the price of an asset. It can be healthy, with steady increases or decreases in price within a general range, or it can be extreme, with rapid price movements in either direction. Crypto volatility is often extreme, with skyrocketing peaks and depressive troughs occurring at a faster pace than in mainstream markets.

There are no indices to measure crypto price volatility, but historical price charts illustrate the extreme price movements in the crypto market. For example, the price of Bitcoin rose by 125% in 2016 and by more than 2000% in 2017.

Factors Influencing Crypto Volatility

Supply and Demand

Like most commodities, the price of Bitcoin is heavily influenced by supply and demand. As Bitcoin is limited to 21 million coins, its price is affected by the circulating supply and how much people are willing to pay. As supply decreases and demand increases, prices are likely to climb.

Investor Actions

Investor actions, particularly those of "Bitcoin whales"—investors with large enough holdings to influence market value—can also drive volatility. If whales were to suddenly sell their Bitcoin holdings, prices would plummet as other investors panicked and followed suit.

Media and Public Speculation

Media outlets, influencers, and industry moguls can create investor concerns, leading to price fluctuations. For example, when media outlets announced Proshare's introduction of its Bitcoin Strategy ETF in October 2021, Bitcoin's price skyrocketed as investors jumped at the chance to gain exposure to cryptocurrency on an official exchange. However, when investors realized the ETF was linked to Bitcoin through futures contracts, prices dropped back down.

Government Regulations

Rumors and changes regarding government regulations can also impact Bitcoin's price. For example, China's government and central bank announced in 2021 that all cryptocurrency transactions were illegal, leading to a massive shutdown of cryptocurrency mining farms in the country and a subsequent drop in Bitcoin's price.

Risk

Crypto-assets are largely unregulated, and the platforms where they are bought and sold may not be protected by financial regulatory bodies. As such, investors may not be protected if the platform fails or is hacked, or if their crypto wallet is stolen by hackers.

Additionally, crypto is not legal tender in many countries, including Australia, and is not widely accepted as payment. This means that if a crypto-asset fails, investors will likely lose all their money, and they will not be protected by existing laws.

Overall, investing in cryptocurrency is a high-risk venture due to the extreme volatility of the market and the lack of regulation surrounding crypto-assets. Investors must be prepared to lose their entire investment and should carefully consider the risks before deciding to invest in this volatile asset class.

Crypto scams and fraud

Crypto scams are becoming increasingly common, and fraudsters are always finding new ways to trick people out of their money. Here are some of the most common types of crypto scams and ways to protect yourself:

Fake Trading Platforms and Wallets

Scammers create fake cryptocurrency trading platforms or fake versions of official crypto wallets to trick people. These fake websites often have domain names similar to legitimate sites, making it hard to tell the difference. They may operate as phishing pages, stealing your login and financial details, or they may allow you to withdraw small amounts initially before shutting down or declining your withdrawal requests.

Phishing Scams

Crypto phishing scams often target private keys to online wallets. Scammers send emails luring recipients to fake websites, where they are asked to enter their private key information. Once they have this, they can steal the cryptocurrency in those wallets.

Pump and Dump Schemes

Fraudsters hype up a particular coin or token through email blasts or social media, causing a rush of traders to buy the coins and driving up the price. The scammers then sell their holdings, causing the asset's value to sharply decline, leaving the traders with losses.

Fake Celebrity Endorsements

Scammers pose as or claim endorsements from celebrities, businesspeople, or influencers to capture attention. They may sell phantom cryptocurrencies that don't exist or promise to match or multiply any cryptocurrency sent to them in "giveaway scams." These scams often involve sophisticated websites and brochures featuring celebrity endorsements.

Blackmail and Extortion

Scammers send emails claiming to have a record of adult websites visited by the recipient and threaten to expose them unless they share private keys or send cryptocurrency.

Cloud Mining Scams

Cloud mining companies allow people to rent mining hardware remotely. However, many of these companies are scams or are ineffective, causing people to lose money instead of earning profits.

Fraudulent Initial Coin Offerings (ICOs)

ICOs are a way for start-up crypto companies to raise money from future users by offering discounts on new crypto coins. Several ICOs have turned out to be fraudulent, with criminals renting fake offices and creating high-end marketing materials to deceive investors.

How to Protect Yourself

• Be wary of promises of guaranteed returns, as no financial investment can ensure future gains.
• Look out for a well-written whitepaper that explains the cryptocurrency's design and functionality. A poor or non-existent whitepaper is a red flag.
• Be cautious of excessive marketing and heavy-handed promotion, as legitimate cryptocurrencies tend to have humble beginnings.
• Be suspicious if you can't find information about the key people running the cryptocurrency.
• Ignore investment opportunities promising free money or cryptocurrency.
• Never share your private wallet keys with anyone.
• When updating your wallet app, be cautious of suspicious behavior, and uninstall the app if necessary.
• Only invest in things you understand, and take your time to research before investing.
• Be skeptical of social media crypto adverts, including those featuring unauthorized images of celebrities.
• Ignore cold calls or unsolicited messages trying to sell you crypto investment opportunities.
• Only download apps from official platforms like the Google Play Store or Apple App Store.
• Research lesser-known cryptocurrencies thoroughly before investing.
• Be cautious of companies promising guaranteed returns or overnight riches.
• Never invest money you can't afford to lose.

What to Do if You're Scammed

If you fall victim to a crypto scam, contact your bank immediately, especially if you've made a payment or shared personal details. Change your usernames and passwords to prevent further damage, and report the scam to the relevant social media platform or fraud body in your jurisdiction (e.g., the Federal Trade Commission in the US).

Regulatory uncertainty

In the US, the Treasury Department has released stringent reporting requirements for business and personal accounts from financial institutions, including cryptocurrency. This adds to a restrictive climate towards crypto, especially 'privacy coins', which promote privacy as their key value proposition. Several exchanges have de-listed certain tokens to avoid regulatory action.

Internationally, the global AML agency, the Financial Action Task Force (FATF), has also increased transactional reporting requirements for virtual asset service providers (VASPs), which include more companies than just centralized exchanges.

The regulatory landscape is further complicated by the fact that privacy coin laws vary by country. Some ban them outright, while others leave them in a legal gray area. For example, South Korea and Japan have made the use and possession of privacy coins illegal.

The lack of regulatory clarity has led some major market-making firms, such as Citadel Securities, to avoid trading cryptocurrencies altogether. Ken Griffin, the founder of Citadel Securities, has stated that he does not want to take on the regulatory risk in this "regulatory void". He believes that thoughtful regulation will make the market smaller but more competitive.

Crypto as a long-term investment

Crypto is a high-risk, volatile investment. The market is extremely unpredictable, and the value of crypto can fluctuate at extreme levels, often based on market speculation.

However, if you are investing in cryptocurrency for the long term, it likely means that you believe that the crypto you are holding has utility and will attract users in the years to come. Here are some tips for investing in crypto as a long-term investment:

• Understand the risks: Crypto is largely unregulated, and there is a chance you could lose all the money you put in.
• Do your research: Understand where the value of the cryptocurrency comes from, and look at details such as potential use cases and total supply.
• Plan how much to invest: It is generally recommended to never invest more than you can afford to lose.
• Choose a trusted exchange: Find a trusted exchange that allows you to buy and sell cryptocurrency.
• Be cautious of scams: Scams are common in the cryptocurrency space, so be sure to research the team behind the cryptocurrency and ensure they are trusted by the community.
• Understand the tax implications: Remember that cryptocurrency investments are subject to tax. You will need to pay capital gains tax when you dispose of your cryptocurrency at a profit.
• Focus on established cryptocurrencies: Large, established crypto assets like Bitcoin and Ethereum have weathered several market cycles and downturns and are tied to a series of financial products.
• Be prepared for volatility: The cryptocurrency market is extremely volatile, so be prepared for potential losses.
• Take a long-term view: Approach the market with a long-term outlook and do not get caught up in short-term speculation.
• Understand the technology: Take the time to learn about the underlying technology powering different crypto assets. This will give you better insight into a project's prospects.

Crypto vs stocks

Investing in cryptocurrencies has become increasingly popular, with Bitcoin and Ethereum being the most well-known. However, the extreme volatility of the crypto market and its lack of regulation make it a high-risk investment. Stocks, on the other hand, have a long history of solid returns and are more regulated, making them a safer option for investors.

Crypto vs. Stocks: The Key Differences

• Ownership Interest: Stocks represent fractional ownership of a company, giving shareholders a claim on the company's assets and cash flow. Cryptocurrencies, in most cases, are not backed by anything and are instead based on speculation and sentiment.
• Price Movement: Stock prices move based on investors' assessments of a company's future success and are influenced by the company's ability to grow its profits over time. Cryptocurrency prices, on the other hand, are driven solely by speculation and market sentiment, making them highly volatile.
• Regulation: Stocks are traded on established stock exchanges and are heavily regulated by government bodies. Cryptocurrencies, however, are less regulated and more decentralised, with varying levels of global regulation.
• Dividends: Stocks may offer dividends, providing shareholders with a steady stream of income. Cryptocurrencies do not offer dividends.
• Trading Fees: Crypto brokers typically charge trading fees for each transaction, while most stock brokers have eliminated these fees.
• Transaction Speed: Stock transactions are generally faster than crypto transactions, which must be approved and verified by the blockchain network, taking several minutes for Bitcoin trades and about 15 seconds for Ethereum trades.
• Custody: Stocks are often held by stock brokers, acting as custodians. Cryptocurrencies may be held in a centrally managed brokerage platform or a cold wallet controlled by the investor.

Pros and Cons of Crypto vs. Stocks

Pros of Investing in Cryptocurrency

• Hedge Against Fiat Currency: Cryptocurrencies are decentralised and not controlled by central banks or governments, offering a potential hedge against inflation.
• Potential for Outsized Gains: Cryptocurrencies have the potential for large gains, with some coins seeing significant price increases since their introduction.
• Growing Number of Coins: There are now thousands of cryptocurrencies to choose from, providing investors with a wide range of options.
• Wide Interest: Cryptocurrencies have gained interest from investors, companies, and even governments, with some countries considering adopting them as legal tender.

Cons of Investing in Cryptocurrency

• Extreme Volatility: The crypto market is highly volatile, and the lack of backing by assets or cash flow makes it susceptible to drastic price swings.
• Cybersecurity Risks: Despite claims of enhanced security, there have been notable hacks and thefts involving cryptocurrencies.
• No Intrinsic Value: Cryptocurrencies have no intrinsic value and are not backed by underlying assets or earnings, unlike stocks.
• Regulatory Risks: The lack of standardised global regulation and the uncertainty around how governments will treat cryptocurrencies pose regulatory risks.

Pros of Investing in Stocks

• Long History of Solid Returns: Stocks have a long track record of producing solid investment returns, with the S&P 500 stock index returning about 10% over the long term.
• Intrinsic Value: Stocks represent ownership in a company and have intrinsic value based on the company's assets, earnings, and future earnings power.
• Accessibility: Investing in stocks has become more accessible due to the emergence of online brokers offering low or no trading fees.
• Stronger Regulation: Stocks and stock exchanges are heavily regulated, providing certain investor protections and transparency.

Cons of Investing in Stocks

• Volatility: While less volatile than cryptocurrencies, stocks can still experience significant price fluctuations, especially individual stocks or growth stocks.
• Lower Potential for Extreme Gains: Broad stock indexes, such as the S&P 500, have lower potential for extreme gains when compared to cryptocurrencies, which can move 10% in a single day.

Portfolio Management and Safety Considerations

When constructing your investment portfolio, you don't have to choose between cryptocurrencies and stocks exclusively. Instead, consider allocating a small portion (e.g., 5% or less) to cryptocurrencies due to their inherent risks, while the majority of your portfolio can consist of a diversified collection of stocks.

In terms of safety, stocks are generally considered safer than cryptocurrencies due to their intrinsic value, regulatory oversight, and long-term track record of solid returns. Cryptocurrencies, on the other hand, offer the potential for substantial gains but come with significant risks, including volatility, cybersecurity threats, and regulatory uncertainties.

Ultimately, the decision to invest in crypto or stocks depends on your risk tolerance, financial goals, and understanding of each asset class.

Frequently asked questions