Cryptocurrency Investment: Worthy Or Risky?

Investing in cryptocurrency has become an increasingly popular topic of discussion, with some people making millions and others losing it all. But is it a good idea to invest in cryptocurrency?

Cryptocurrency is a digital or virtual currency that uses cryptography to secure transactions. It is usually based on blockchain technology, which is a distributed ledger enforced by a network of computers. Cryptocurrencies are not issued or regulated by a central authority, which means they are theoretically immune to government interference.

There are several advantages to investing in cryptocurrency. Firstly, it removes single points of failure, as there is no central authority that can collapse. Secondly, it is easier to transfer funds between parties without the need for a trusted third party like a bank. Cryptocurrencies can also be used to generate returns, and they streamline remittances.

However, there are also several disadvantages and risks associated with investing in cryptocurrency. Cryptocurrencies are highly volatile, which means their prices can fluctuate drastically. They are also pseudonymous, which means that while they provide a level of anonymity, they still leave a digital trail that can be followed by authorities. Cryptocurrencies have become popular for criminal activities such as money laundering and illicit purchases. Additionally, there are user risks, regulatory risks, counterparty risks, management risks, programming risks, and the possibility of market manipulation.

Overall, investing in cryptocurrency can be a risky proposition. It may be suitable for someone who enjoys speculating and can financially handle potential losses. However, it may not be a wise investment for those seeking to grow their retirement portfolio or save for the long term. It is important for individuals to carefully consider the risks and rewards before deciding whether to invest in cryptocurrency.

The risks of investing in cryptocurrency

Investing in cryptocurrency is risky due to the potential for high losses from security breaches, fraud, and market volatility. Here are some key risks to consider:

• Security Breaches and Fraud: Cryptocurrency exchanges are vulnerable to hacking and other criminal activities. Security breaches have resulted in significant losses for investors, and the decentralised nature of cryptocurrency makes it attractive to criminals and challenging to regulate.
• Volatility: Cryptocurrency values can fluctuate drastically in a short period, often based purely on speculation. This volatility can lead to substantial gains or losses for investors and makes it challenging to create a long-term investing plan.
• Unproven Rate of Return: The lack of regulations in the cryptocurrency market results in an unpredictable pattern of value fluctuations. This makes it difficult to calculate returns and creates uncertainty about the potential for long-term gains.
• Regulatory Risks: The legal status of cryptocurrencies varies across jurisdictions, and regulations are still evolving. A sudden regulatory change or crackdown could negatively impact the market and make it challenging to sell cryptocurrencies.
• Counterparty Risks: Many investors rely on exchanges or custodians to store their cryptocurrency. Issues with these third parties, such as theft or loss, could result in the loss of one's entire investment.
• Management Risks: The lack of coherent regulations leaves investors vulnerable to deceptive or unethical management practices. There have been cases of management teams failing to deliver a product after raising funds.
• Programming Risks: The use of automated smart contracts in investment and lending platforms introduces the risk of bugs or exploits that could result in the loss of investor funds.
• Market Manipulation: Cryptocurrency markets are susceptible to manipulation by influential individuals, organisations, and exchanges acting unethically.
• High Energy Consumption: Cryptocurrency mining, particularly for popular cryptocurrencies, requires significant energy, contributing to environmental concerns.

The pros of investing in cryptocurrency

• Decentralized system: Cryptocurrencies are decentralized, meaning they are not issued or regulated by a central authority like a bank or government. This makes them immune to government interference or manipulation and removes the possibility of a single point of failure, such as a large financial institution collapse causing a global crisis.
• Secure transactions: Cryptocurrencies use cryptographic techniques to secure transactions, making it nearly impossible to counterfeit or double-spend. Transactions are recorded in a public ledger called a blockchain, which is challenging to tamper with.
• Faster and cheaper money transfers: Cryptocurrency transfers are typically faster and cheaper than traditional money transfers because they do not require third-party intermediaries like banks.
• Diversification: Cryptocurrencies can provide diversification to an investment portfolio, especially as they can behave differently from other asset classes under the same economic conditions.
• High returns: Cryptocurrencies can provide astronomically high returns overnight. For example, some early investors in Bitcoin have made substantial fortunes.
• New asset class: Cryptocurrencies are maturing and developing into a new asset class, attracting the interest of large professional fund managers.
• Potential for future growth: As the cryptocurrency sector is still relatively new, there is potential for future changes that could make investing in cryptocurrencies even more attractive. For example, the development of stablecoins, which are linked to the value of a fiat currency, could reduce price volatility.

The cons of investing in cryptocurrency

• Price volatility: Cryptocurrencies are prone to extreme price fluctuations, with values soaring and plummeting in a short period. This volatility is driven by supply-demand dynamics and speculation, making it challenging to predict price movements and increasing the risk of losses.
• High-risk investment: Cryptocurrencies are speculative and high-risk investments. The lack of regulation and the anonymous nature of transactions make them vulnerable to fraud, security breaches, and criminal activities. The possibility of losing the entire investment is very real.
• Uncertain long-term viability: Cryptocurrencies are a relatively new concept, with Bitcoin, the first cryptocurrency, emerging in 2008. Their long-term viability is uncertain, and they haven't proven themselves as long-term investments yet.
• Scalability issues: While transactions are generally faster than traditional banking systems, cryptocurrencies face significant scalability issues. The blockchain technology underlying them has limitations, leading to slower processing times as the number of transactions increases.
• Security risks: The decentralised nature of cryptocurrencies makes them susceptible to security risks such as hacking and phishing. New investors are particularly vulnerable to these threats, and the loss of a private key can result in the irreversible loss of the entire investment.
• Regulatory uncertainty: The regulatory landscape surrounding cryptocurrencies is constantly evolving and varies across countries. This uncertainty poses challenges for investors and businesses, as they must navigate a complex and dynamic environment of compliance requirements and potential legal risks.
• Lack of diversification: Cryptocurrencies are a single asset class, and investing in them does not provide the benefits of diversification. A diversified portfolio typically includes a mix of stocks, bonds, and other assets to reduce risk and stabilise returns.

How to invest in cryptocurrency

Pick a Broker or Cryptocurrency Exchange

You can buy cryptocurrency through a broker or a cryptocurrency exchange. Examples of brokers include Robinhood and SoFi, while cryptocurrency exchanges include Coinbase, Gemini, and Binance.US. Brokers may charge higher fees, but some investors prefer them for the added security they offer. Cryptocurrency exchanges can be overwhelming for new investors, but they offer more options.

Set Up an Account

To create an account, you'll need to provide personal information and verify your identity. This may include entering details from your driver's license or passport, and sometimes a photo.

Add Funds to Invest

You can add funds to your account through various methods, including bank transfers, wire transfers, or debit/credit card payments. Credit card deposits often incur higher interest rates and extra fees, so be cautious.

Initiate Your Cryptocurrency Transaction

Once your account is funded, decide which cryptocurrency to buy, and how much. Many exchanges allow you to buy fractional shares of high-value cryptocurrencies.

Keep Your Cryptocurrency Secure

Use a digital wallet to store your cryptocurrency. A hot wallet is connected to the internet and is more convenient but poses a higher risk of theft. A cold wallet, like a USB or hard drive, is offline and more secure, but if you lose the associated keycode or the device fails, you could lose access to your cryptocurrency.

Other Ways to Invest in Crypto

• Invest in crypto companies: You can invest in companies with a partial or total focus on cryptocurrency, such as mining companies, hardware makers, and companies that support crypto.
• Invest in crypto funds: You can invest in crypto-focused funds, including exchange-traded funds (ETFs), index funds, futures funds, and cryptocurrency investment trusts.
• Invest in a crypto Roth IRA: A crypto IRA can provide tax advantages and more secure storage for your crypto holdings.
• Become a crypto miner or validator: Mining or validating crypto can earn you rewards in crypto, which you can hold or exchange.

Things to Consider Before Investing

• Project details: Understand the unique investment proposition of each cryptocurrency.
• Your risk profile: Be honest about how much volatility you can handle. Crypto prices can be extremely volatile, and you should be prepared for major price drops.
• Your investment goals: Ensure a crypto investment aligns with your larger financial goals. Don't rely entirely on crypto for essential goals like retirement. Diversification is key.

How to store cryptocurrency

Storing cryptocurrency securely is essential to prevent theft and fraud. Here is a comprehensive guide to help you understand the different methods of storing your crypto assets:

Custodial Wallets:

These are wallets provided by a third-party service, such as a crypto exchange like Coinbase, where your crypto is stored either through cold (offline) storage, hot (online) storage, or a combination of both. Custodial wallets are convenient, especially for beginners, as they require less effort and provide easy access to your crypto for trading. However, the downside is that you don't have control over your private keys, and there is a risk of the exchange being hacked or going bankrupt.

Non-Custodial Wallets:

These wallets are under your control, and you can store your crypto keys without involving a third party. Non-custodial wallets can also be hot or cold wallets.

Hot Wallets:

Hot wallets are software applications that store your crypto online. They can be in the form of desktop, mobile, or web-based apps. Hot wallets are convenient for frequent trading as they provide quick and easy access to your crypto funds. However, they carry a higher risk of being hacked since they are always connected to the internet.

Cold Wallets:

Cold wallets, also known as hardware wallets, are offline storage devices similar to USB drives. They are considered one of the safest options for storing crypto as they are not connected to the internet and are, therefore, less susceptible to hacking attempts. Some popular options include the Ledger Nano X and Trezor Model T. While cold wallets offer enhanced security, they are less convenient for frequent trading due to the need to connect them to a device for transactions.

Paper Wallets:

A paper wallet is a simple and cost-effective way to store your crypto offline. It involves printing out your public and private keys, usually in the form of QR codes, and storing them in a safe place. While this method provides strong security, it is less user-friendly, and there is a risk of losing the paper or it being stolen.

Best Practices for Storing Cryptocurrency:

• Use a combination of hot and cold wallets. Store the majority of your crypto in a cold wallet for enhanced security, and use a hot wallet for smaller amounts that you plan to trade frequently.
• Always back up your crypto wallet and recovery phrases (seed phrases) in multiple secure locations.
• Never share your private keys, seed phrases, or recovery phrases with anyone, and avoid storing them on devices or cloud services that are connected to the internet.
• Use strong passwords and regularly update your software and operating systems to protect against potential security vulnerabilities.
• Consider using multi-signature transactions, which require approval from multiple people, to add an extra layer of security.
• Be vigilant against phishing and smishing attempts, and never share your multifactor authentication (MFA) codes.

Frequently asked questions