Cryptocurrency: Safe Investment Or Risky Business?

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 safe investment?

Cryptocurrency is a digital or virtual currency that uses cryptography to secure transactions. It is usually built on blockchain technology, which makes it hard for hackers to tamper with. Cryptocurrencies are decentralised, meaning they are not issued or regulated by a central authority. This makes them immune to government interventions but also means there is a lack of regulatory protection for investors.

There are several risks associated with investing in cryptocurrency, including high volatility, the possibility of hacking, fraud, and permanent loss in the case of a forgotten password. On the other hand, cryptocurrency can provide protection against inflation, is cost-effective, and offers fast transactions.

While some countries have banned cryptocurrency, others are warming up to the idea of digital coins. The answer to whether it is safe to invest in cryptocurrency is tricky and depends on a variety of factors, including an investor's risk appetite and the regulatory environment in their country.

Cryptocurrency is susceptible to fraud and theft

There are several ways in which fraudsters and thieves target cryptocurrency. One common method is through initial coin offerings (ICOs), which are the first offerings of a particular cryptocurrency for sale. Many ICOs are completely fabricated, with phony bios of non-existent team members and technical whitepapers copied from other legitimate cryptocurrencies. Fraudsters can also attempt to manipulate the markets where cryptocurrencies or related derivative products are traded through improper market manipulation, including spoofing, front-running, and churning.

Another way that criminals target cryptocurrency is by hacking into investors' crypto wallets and stealing their currency. They can also set up fake wallets to defraud counterparties or phony crypto exchanges to steal customers' money. Additionally, scammers may pose as investment advisors or influencers to prey on unwary investors.

The decentralised nature of cryptocurrency also makes it challenging to identify the source of fraud and the storage of assets. Unlike some exchanges that collect know-your-customer information, private digital wallets are owned by individuals with no requirements to provide personal identification information. This lack of regulatory oversight makes it difficult to track down the perpetrators of fraud or theft.

To protect yourself from fraud and theft when investing in cryptocurrency, it is important to do your research and only invest in well-known and reputable cryptocurrencies. It is also crucial to use secure digital wallets and follow best practices for protecting your personal and financial information.

It is volatile

Volatility is a natural part of market activity, and it refers to changes in the price of an asset. Crypto volatility is in a league of its own compared to traditional financial markets. The price of Bitcoin, for example, rose by 125% in 2016 and then by more than 2,000% in 2017. This volatility is due to a combination of factors.

Firstly, news developments and speculation fuel price swings in crypto markets, and their effect is exaggerated due to a lack of liquidity. Crypto markets lack a robust ecosystem of institutional investors and large trading firms, which leads to heightened volatility.

Secondly, the cryptocurrency market is still emerging and minuscule compared to traditional currencies or gold. This means that even smaller forces, such as a group of people holding large amounts of crypto (known as "whales"), can influence the trade. If these whales sell their coins, it can lead to a crash in prices.

Thirdly, the purely digital nature of cryptocurrencies means that their price is determined by the laws of supply and demand. In the absence of any stabilising factors, such as government backing, any number of reasons may lead to fluctuations in demand or supply.

Lastly, the blockchain technology that cryptocurrencies are based on is still evolving, and there are concerns about scalability. For example, if a smart contract is not validated within the expected timeframe, it can create sudden downward pressure on prices.

The frequent involvement and withdrawal of part-time investors, who may lose patience when quick gains are not realised, also contribute to the volatility of the cryptocurrency market.

It is unregulated

Investing in cryptocurrencies is risky due to their unregulated nature. Cryptocurrencies are not regulated by any central government authorities, making them immune to government interventions. This lack of regulation has benefits and drawbacks. On the one hand, it allows cryptocurrencies to be decentralised, faster, and cheaper to transfer. On the other hand, it means that there is no sovereign guarantee or approval, and the price volatility, alleged use in criminal activities, and high energy consumption for mining coins are considered key challenges.

The unregulated nature of cryptocurrencies also means that they are subject to sudden policy changes by governments. For example, in November 2019, Bitcoin's value sank when China accelerated a crackdown on cryptocurrency businesses. Conversely, whenever a regulatory "victory" emerges, prices surge temporarily. For instance, in January 2024, after years of Bitcoin Spot ETF denials from regulators, Bitcoin Spot ETF approvals caused its price to climb over the following months.

The lack of regulation also means that cryptocurrencies are more vulnerable to security breaches and hacks, which have led to sizable losses for investors. Additionally, the lack of regulation makes it difficult to track and recover funds lost in these security breaches.

The classification of cryptocurrencies also varies among regulatory agencies, with the IRS treating it as property and the CFTC considering it a commodity in the US. This discrepancy in classification further highlights the lack of clear regulation in the industry.

While some countries have recognised cryptocurrencies as property and developed frameworks for their regulation, others have placed outright or partial bans on them. The EU, for example, has implemented the Markets in Crypto Assets (MiCA) regulation, which defines cryptocurrency assets and how they should be regulated in the bloc.

It is susceptible to hacking

Susceptibility to Hacking

Cryptocurrency is susceptible to hacking, and this susceptibility is inherent in its foundational technology, blockchain. While blockchain technology is generally secure, it is not unhackable.

51% Attacks

Susceptibility to 51% attacks is inherent to most cryptocurrencies. This type of attack occurs when a hacker or group of hackers gains control of more than half of a blockchain network's computing power. This allows them to rewrite transaction histories and spend the same cryptocurrency multiple times, a practice known as "double-spending."

The larger and more complex a blockchain network is, the more difficult and expensive it becomes to carry out a 51% attack. For example, renting the mining power needed to attack Bitcoin would cost over $260,000 per hour. However, smaller and less complex blockchains are more vulnerable to this type of attack.

Creation Errors

The creation of a blockchain may involve security glitches or errors, especially in the case of larger, more intricate blockchains. These vulnerabilities can be exploited by hackers, who can then steal money from users without being detected since blockchain transactions cannot be altered.

Insufficient Security

Many blockchain hacks have occurred on cryptocurrency exchanges, where users can trade cryptocurrency. If the security practices surrounding these exchanges are weak, hackers can more easily access user data and steal cryptocurrency.

Other Types of Theft

In addition to hacking, cryptocurrency can be stolen through scams and ransomware. For example, in a romance scam, thieves pose as romantic interests and then convince their targets to send them cryptocurrency to fund an emergency. With ransomware, thieves encrypt files or data and demand cryptocurrency as payment for releasing them.

Safeguarding Cryptocurrency

To safeguard their cryptocurrency, investors should ensure that their private keys are stored offline in cold storage. They should also only transfer the keys they need to a hot wallet when making a transaction and remove them from the hot wallet immediately afterward. Additionally, investors should only let someone else store their keys if they are comfortable with the risks.

It is not widely accepted

Cryptocurrency is not widely accepted due to a combination of social, regulatory, and technical factors.

Firstly, cryptocurrency faces social and philosophical challenges. The concept of decentralisation that underpins cryptocurrency is a significant departure from the traditional financial system, which is based on centralised institutions and government control. People are accustomed to centralised systems where they can place their trust in banks and governments. The idea of a decentralised, leaderless currency such as Bitcoin is unusual and can be difficult to accept, especially since it challenges the established rules of the game.

Secondly, regulatory issues are a barrier to widespread acceptance. Cryptocurrency is not issued or regulated by central government authorities in many countries, including India. The lack of regulatory support means that cryptocurrency is not widely accepted as a form of payment and is not legal tender in most countries, including Australia. Additionally, the absence of regulation increases the risk of fraud and theft, as demonstrated by the collapse of the FTX platform in 2022, where customers lost billions of dollars.

Finally, technical challenges also play a role in the limited acceptance of cryptocurrency. The price volatility of cryptocurrencies, their alleged use in criminal activities, and the high energy consumption required for mining are all concerns. The lack of widespread technical infrastructure, such as ATMs and point-of-sale systems that support cryptocurrency, also hinders its acceptance.

While cryptocurrency has grown in popularity, these social, regulatory, and technical factors continue to pose challenges to its widespread acceptance.

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