Cryptocurrency: Risky Business Or Missed Opportunity?

Cryptocurrency is a digital or virtual currency secured by cryptography, which makes it nearly impossible to counterfeit or double-spend. Most cryptocurrencies exist on decentralised networks using blockchain technology. Cryptocurrencies are generally used to pay for services or as speculative investments. However, there are several reasons why not everyone invests in cryptocurrency. Firstly, crypto prices are extremely volatile, and the industry is filled with uncertainty. Secondly, there are tax consequences to buying and selling cryptocurrencies. Thirdly, the environmental impact of mining cryptocurrencies is significant. Lastly, there are security concerns, as theft remains one of the most common threats to cryptocurrency users.

Crypto is a volatile asset class

Cryptocurrency is widely considered to be a volatile asset class. Volatility refers to how much the price of an asset has increased or decreased over a given period, and crypto has seen a series of steep rises and falls. For example, in one day, Bitcoin's value dropped by 30%. This volatility is driven by several factors, including its speculative nature, news events, and the unique characteristics of the crypto market.

Speculation and Intrinsic Value

Crypto's market value is based on speculation, which is essentially educated guesswork. Without anything intrinsically valuable backing up the currency, such as gold or diamonds, crypto's value depends on how much people are willing to trade for it. This makes crypto a highly speculative investment, and investing in speculative assets is a guaranteed way to introduce volatility to a portfolio.

News Events and Market Sentiment

Speculation and news events, such as COVID-19, drive price swings in the crypto market. Positive or negative news coverage can impact crypto prices, and the effects of these events are often exaggerated due to the unique features of the digital asset space. Additionally, crypto markets are heavily influenced by investor sentiment. The immaturity of the crypto market means that positive or negative views can spread like a contagion, impacting price movements.

Supply and Demand Dynamics

The distribution between supply and demand also plays a role in crypto volatility. Certain crypto assets, like Bitcoin, have a limited supply, and sudden increased demand can put upward pressure on prices, increasing volatility. Large holders, often called "whales," can also significantly impact prices by buying or selling large quantities of a particular asset.

Market Maturity and Regulation

The crypto market is still in its early stages of development and acceptance. As a result, investors may be uncertain about crypto's long-term future utility and regulatory standing, leading to price discovery as a major driver of volatility. The lack of comprehensive regulation by government bodies also contributes to the volatility, as regulatory changes and crackdowns can affect the market in unpredictable ways.

Comparisons to Traditional Markets

Crypto market volatility is often compared to traditional markets, and it is in a league of its own. While stocks and bonds exhibit varying levels of volatility, crypto experiences more extreme and rapid price movements. For instance, Bitcoin has witnessed over eight 50% corrections in its 15 years of existence, showcasing its volatile nature.

It's a speculative investment

Cryptocurrencies are highly speculative investments. They are digital assets secured by cryptography, which makes them nearly impossible to counterfeit or double-spend. However, their value is highly volatile and difficult to predict. This makes them a risky investment, and it can be challenging to determine whether they have long-term potential.

The High-Risk, High-Return Investment

Speculative investments are typically short-term and carry a high degree of risk, but also the potential for high returns. Investors who engage in such investments are known as speculators and are often compared to gamblers due to their willingness to take significant risks without conducting thorough research.

Speculators focus on profiting from price fluctuations, such as short-term trading in overvalued markets or targeting undervalued securities. In the context of cryptocurrency, this could mean taking advantage of the rapid surges and crashes in the value of coins like Bitcoin, which climbed to nearly $65,000 in November 2021 before dropping to just over $20,000 a year later.

The Volatile Nature of Cryptocurrency

The highly volatile nature of cryptocurrencies makes them a speculative investment. The value of coins like Bitcoin can fluctuate drastically, and it is challenging to predict whether they will increase or decrease in the long run. This volatility is due in part to the complex and unpredictable factors that influence cryptocurrency prices, such as changes in supply and demand, media coverage, and the actions of influential individuals or organizations.

Additionally, the regulatory status of cryptocurrencies is still evolving, and sudden changes or crackdowns could impact their value. The decentralized nature of cryptocurrencies, while intended to prevent single points of failure, also contributes to their volatility as it allows for faster transactions without the stability typically provided by central authorities.

The Uncertain Future of Crypto

The long-term potential of cryptocurrencies is uncertain, contributing to their speculative nature. While some people argue that cryptocurrencies are the future of finance and will revolutionize the way we interact with money, others believe they are purely speculative and have no fundamental value.

The success of cryptocurrencies depends on their continued adoption and the development of practical use cases. Currently, cryptocurrencies are primarily used for investment and speculative purposes, with only limited real-world applications, such as streamlined remittances and decentralized finance applications.

The Bottom Line

Whether a cryptocurrency investment is speculative depends on the specific coin and its long-term potential. Some cryptocurrencies, like Bitcoin and Ethereum, have innovative features and are continuously adopted for more use cases, making them less speculative. In contrast, coins that lack a clear purpose or long-term vision are more likely to be considered speculative.

Crypto is a decentralised, censorship-resistant store of value

The decentralised nature of crypto is enabled by blockchain technology. A blockchain is a digital ledger that records transactions across many computers, making it nearly impossible to counterfeit or double-spend. This distributed ledger is enforced by a disparate network of computers, which makes it extremely difficult to alter any data stored on it. Blockchain technology also enables crypto to be "censorship-proof" as it prevents any single entity from having undue influence over the system.

The benefits of crypto being a decentralised, censorship-resistant store of value include faster and cheaper money transfers, increased financial freedom and security, and the removal of single points of failure. For example, crypto can be used to streamline remittances, as it does not require third-party intermediaries like banks. Additionally, crypto is not subject to the same inflationary pressures as fiat currencies because its supply is typically limited and cannot be arbitrarily inflated by governments or central banks.

However, it is important to note that crypto does not provide absolute censorship resistance. Transactions still rely on networks controlled by internet service providers or governments, which can be shut down or censored. Additionally, the pseudonymous nature of blockchain wallet addresses can make it challenging to mask one's identity completely.

It's a new, transformative technology

Cryptocurrency is powered by blockchain technology, a networking protocol that allows computers to work together to keep a shared, tamper-proof record of transactions. Blockchain was created in 2008 by a person or group of people using the name or pseudonym Satoshi Nakamoto. It is a distributed ledger with growing lists of records (blocks) that are securely linked together via cryptographic hashes. Each block contains a cryptographic hash of the previous block, a timestamp, and transaction data.

Blockchain technology has many potential applications beyond cryptocurrency and could be transformative on a global scale. For example, it can be used to secure governments' data and improve various systems, such as land title registries. In the healthcare sector, blockchain technology helps researchers use AI to accurately predict the presence of cancer in patient tissue samples. In the logistics industry, blockchain's distributed ledger and ability to track shipping containers' movements can increase efficiency and reliability.

In the financial sector, blockchain technology is expected to have a significant impact on global finance. Former SEC Chairman Jay Clayton stated that the future of financial markets depends on successfully adopting it. Goldman Sachs CEO David Solomon has also praised the technology's far-reaching implications for the global economy. Blockchain technology removes third parties and single points of failure, making it more secure than traditional payment systems. It also enables faster and cheaper money transfers.

Despite the potential benefits of blockchain technology, it is important to consider the risks and challenges associated with its implementation. These include regulatory uncertainties, high energy consumption, and the potential for criminal activities.

There are security concerns

The decentralised nature of cryptocurrency means that it is not controlled by any single agency, organisation, or governing body. This means that there is no recourse for retrieving your investment if your private key is stolen. A private key is a complex password that grants access to a digital account. If hackers gain access to your computer, they can use your private key to access your digital account.

Additionally, cryptocurrency exchanges, where digital money is bought and traded, are inconsistently regulated. They lack the same level of governmental oversight or auditability as traditional banks. This makes them a target for hackers. In the past, several exchanges have made headlines due to massive security breaches. For example, Coincheck had more than $550 million worth of crypto stolen by hackers, and Bithub lost about $30 million.

Another security concern is phishing. This is when hackers mimic a trustworthy company, like a cryptocurrency trading platform, and send emails to subscribers to convince them to take a specific action. This could be clicking on a harmful website or providing login information. The goal is to trick cryptocurrency users into giving away their digital assets.

Finally, the use of external software or third-party applications to manage digital assets can also increase exposure to potential cybersecurity risks. For example, crypto tax reporting platforms have been targeted by hackers.

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