Crypto: A Risky Bet I Won't Take

Investing in crypto has become an increasingly popular topic of discussion, but there are several reasons why someone might choose not to. Firstly, cryptocurrencies are difficult to value or evaluate, as they don't represent for-profit corporations and don't reflect supply and demand in the same way that stocks do. This makes it hard to determine their real value and creates a risky investment. Secondly, crypto is prone to extreme volatility, with prices fluctuating dramatically and often losing 30-40% of their value within a single weekend. Thirdly, there is very little regulation in the crypto market, leaving investors vulnerable to fraud, a lack of transparency, and the potential for digital theft. Other reasons include the fact that cryptocurrencies do not generate cash flow, are not backed by tangible assets, and are prone to hoarding.

No government backing

One of the main reasons I don't invest in crypto is that it's not backed by governments. Cryptocurrency is decentralized and does not require oversight by a central government authority. While some people find this appealing, others are deterred by the lack of government involvement.

The value of fiat money is protected by the credibility of the government and central banks tasked with controlling money supply. Central banks are independent but have considerable political influence, which is essential to ensuring the value of fiat money. Cryptocurrencies, on the other hand, are highly volatile and subject to fluctuating prices, leading some investors to fear that their digital investments could diminish with no government intervention to protect them.

Some critics argue that the lack of government backing makes cryptocurrency inherently valueless. They argue that the value of fiat currencies is derived from the trust that users place in them, whereas cryptocurrencies lack this trust. This argument, however, can be refuted by pointing out that users also place trust in digital assets, and the value of cryptocurrencies like Bitcoin is based on their limited supply and the network of users who value them.

While some nations, like El Salvador, have adopted Bitcoin as legal tender, others refuse to recognize it as such. Some treat it as a commodity or property, while others, like China, have banned it completely. The European Union has taken steps to regulate cryptocurrency by enacting regulations requiring crypto service providers to identify and suppress illegal activity.

Despite the lack of widespread government backing, some national governments have issued their own cryptocurrencies. China, for example, is a leader in developing its government-backed digital currency, the digital yuan (e-CNY), with numerous pilot projects underway. Other countries, like Japan, Sweden, Estonia, the UK, and the US, are also exploring central bank digital currency (CBDC) initiatives.

No intrinsic value

Cryptocurrency has no intrinsic value and investors could lose all their money, according to the Bank of England's governor, Andrew Bailey. Bailey stated that cryptocurrencies have no intrinsic value, and that people who invest in them should be prepared to lose all their money.

Bitcoin, for example, has no intrinsic value and is not backed by anything. Bitcoin investors seem to be relying on the greater fool theory—that is, they need to find someone willing to buy the asset at an even higher price to profit from an investment.

However, the same can be said about other currencies like gold and fiat. Gold is thought to have intrinsic value because of its applications in industries like dentistry and electronics, but as you further analyse the claim, it becomes clear that gold doesn't have much intrinsic value either.

The value of any currency comes from the backing of the state and the trust that people have in the government. Cryptocurrencies, on the other hand, are decentralised and do not require a central government to oversee their transactions. This lack of government oversight is a significant reason why some people choose not to invest in cryptocurrencies.

High risk

Crypto assets are very risky. The high volatility of cryptocurrencies means that their value may rise and fall suddenly and significantly, and these changes are hard to predict. A study of more than 4,000 cryptocurrencies between 2015 and 2022 found that high-risk cryptocurrencies generally underperformed their low-risk counterparts. Cryptocurrencies with the most idiosyncratic (asset-specific) risks yielded an average annualised return of -9.36%, while those with the least idiosyncratic risks yielded an average annualised return of 80.6%.

Crypto assets are also subject to constant changes, and prices may change dramatically with little warning. If you choose to buy, sell, or speculate in crypto, be aware that you could lose some or all of your investment. For example, while Bitcoin yielded a return of 53.5% over the year ending in June 2023, Dogecoin underperformed with a return of -4.8%.

Another risk associated with crypto assets is the lack of regulation. Some crypto asset exchanges and platforms are unregulated, which presents significant risks to investors because key investor protections may be missing. These include the secure handling of client funds, the safekeeping of assets, protection of personal information, and measures against market manipulations or other harmful practices.

Additionally, crypto assets are not covered by protection funds in the same way that traditional investments are. For example, the Canadian Investor Protection Fund does not cover crypto assets, and federal and provincial/territorial deposit insurance plans also do not offer coverage. This means that if the crypto trading platform or wallet provider that holds your crypto assets goes out of business or declares bankruptcy, you may lose your investment.

Furthermore, crypto assets are frequently targeted by hackers, fraudsters, and scammers. As crypto assets are based on digital technology, they are susceptible to hacking attempts, and fraudsters can gain access to your keys and wallets. Investment scams are also common, with fraudsters using internet ads, social media, or websites to lure victims into buying crypto assets and promising high returns.

In summary, the high risks of crypto investments include the potential for significant and unpredictable losses, the lack of regulation and investor protections, the absence of coverage by protection funds, and the constant threat of hacking, fraud, and scams.

Lack of understanding

A lack of understanding of cryptocurrencies and the technology that underpins them is a significant reason why many people choose not to invest in crypto.

Complexity of Cryptocurrencies and Blockchain Technology

The world of cryptocurrencies can be confusing for newcomers, with its own unique vocabulary and technical concepts. Terms like "blockchain", "decentralization", "mining", and "distributed ledger technology" can be daunting for those unfamiliar with the field. Understanding how cryptocurrencies work, how they are created, and how their value is determined requires a significant amount of time and effort.

For example, blockchain technology, which serves as the foundation for many cryptocurrencies, is a complex concept to grasp. A blockchain is a decentralized digital ledger that records transactions across many nodes, ensuring security and transparency. Understanding the intricacies of blockchain technology, including concepts like consensus algorithms, block rewards, and smart contracts, can be challenging for those outside the industry.

High-Risk Nature of Crypto Investments

The high-risk nature of crypto investments is another factor that contributes to a lack of understanding. Cryptocurrencies are known for their extreme volatility, with prices fluctuating drastically in response to news, events, and market sentiment. This volatility can be off-putting to potential investors who are unsure about the underlying factors driving these price movements.

Additionally, the concept of intrinsic value versus speculative value is crucial to understanding crypto investments. Critics argue that cryptocurrencies, unlike traditional investments, do not have intrinsic value tied to tangible assets or cash flow generation. This perception of speculative value makes it challenging for potential investors to evaluate the true worth of cryptocurrencies and predict their future value.

Regulatory and Tax Considerations

The regulatory landscape surrounding cryptocurrencies can be complex and ever-changing, varying across different countries and jurisdictions. Understanding how governments and regulatory bodies view and treat cryptocurrencies is essential for potential investors. The lack of regulatory clarity in some regions may deter individuals from investing, as it introduces an element of uncertainty and potential legal risks.

Moreover, the tax implications of crypto investments can be confusing. The tax treatment of cryptocurrencies differs across countries, and the rules are still evolving. Understanding how capital gains, income, or other taxes apply to crypto transactions can be challenging, and the potential tax liabilities may deter some individuals from investing.

Information Overload and Misinformation

The crypto space is filled with a vast array of information, including white papers, technical analyses, news articles, and social media posts. Sorting through this abundance of information to separate fact from fiction can be overwhelming. Misinformation and scams are prevalent in the crypto industry, and it can be challenging for newcomers to discern reliable sources from misleading ones.

Lack of Trust in Decentralized Systems

Cryptocurrencies, by their very nature, are decentralized and lack the traditional centralized authorities that oversee fiat currencies. This lack of central control and regulatory oversight can be concerning for potential investors who are accustomed to the traditional financial system. The idea of trusting a decentralized network, often facilitated by anonymous or pseudonymous developers, can be a significant barrier for those who are unfamiliar with the concepts of decentralization and distributed trust.

In summary, a lack of understanding about cryptocurrencies and the underlying blockchain technology, the high-risk nature of crypto investments, complex regulatory and tax considerations, information overload, and the decentralized nature of the industry are all factors that contribute to individuals' reluctance to invest in crypto. Educating oneself and staying informed about the latest developments in the crypto space are crucial steps towards making informed investment decisions.

Security issues

The main security issues with blockchain and cryptocurrency are as follows:

• The complexity of the technology: It is a difficult system to create from scratch, and one small misstep could result in a compromised system. This complexity also makes it harder for the average person to understand the risks and functions.
• The size of the network: Blockchain requires hundreds, preferably thousands, of nodes working in unison. This makes the system vulnerable to attack and corruption during the early stages of growth. For example, if a single user gains control of 51% of the nodes, they may be able to control the outcomes.
• The speed and efficiency of the network: The blockchain's design may compromise its ability to process exchanges at a suitable rate. If the system becomes too complex or in-demand before developing a supportive infrastructure, it can lead to data storage and transaction speed issues.
• The politics of execution: Blockchain-based currencies are decentralised and international, which could make government-controlled currencies intrinsically less valuable. Some national governments are introducing heavier regulations to control blockchain before it threatens their economy or grows too powerful. This could postpone the widespread adoption of the technology.
• Third-party systems: Blockchain and cryptocurrency systems are vulnerable to security issues in third-party systems. For example, NiceHash, a third-party Bitcoin mining marketplace, was hacked and lost more than 60 million dollars in cryptocurrency.
• Cryptographic keys: Blockchain transactions use public and private cryptographic keys that are nearly impossible to crack. However, a cybercriminal could obtain these keys through more conventional means, such as if a user stores the keys on an insecure platform.
• Traditional scams: Blockchain users are vulnerable to traditional scams, such as phishing or spoofing.
• Hacking a payment gateway: Even using a genuine payment gateway with the correct address can result in a loss of money. In June 2017, the most popular Web wallet for the Ethereum Classic cryptocurrency started stealing money from users' wallets. Hackers had convinced the hosting provider that they were the real domain owners and intercepted cash flows.
• User address error: There is a risk specific to cryptocurrencies that money could be lost due to an error in the address to which the transfer is made. In the case of Ethereum, if the last digit of the address isn't copied, the money could disappear.
• Loss of a wallet file: Most users store their cryptocurrency wallet files on their computers, so they can be stolen using malware or lost if the hard disk crashes.
• Insecure ICOs: In 2017, investing in projects associated with blockchain and cryptocurrencies became popular. This type of fundraising is called an ICO (Initial Coin Offering). However, the cryptocurrency market is not regulated, there are no risk assessment mechanisms, and there is no guarantee of a return on investments.

Tips for Crypto-Investors

• Always verify a Web wallet's address, and don't follow links to an Internet bank or Web wallet.
• Write down a mnemonic phrase that allows you to recover a crypto wallet if you lose it or forget your password.
• Keep a cool head and make informed decisions when crypto-investing, and don't panic or hurry.
• Always remember that crypto-investment is very risky. Do not invest more than you're ready to lose. Diversify your investments.
• Use cryptocurrency hardware wallets, such as Trezor Wallet and Ledger Nano S.
• Run high-quality antivirus protection to protect the devices used to access crypto wallets.

Frequently asked questions