Crypto Investment: Risky Business Or Smart Money Move?

Investing in crypto has become an increasingly popular topic of discussion, with many people speculating about whether or not to add it to their portfolio. Cryptocurrency has been described as a transformative technology that could revolutionise several industries, from shipping and supply chains to banking and healthcare. However, it is important to consider both the potential benefits and drawbacks before making any investment decisions. On the one hand, crypto offers a reliable, long-term store of value that is independent of any government or political body, and it has the potential to become a widely accepted form of currency. On the other hand, it is a highly volatile and speculative asset that is subject to complex security risks and little to no regulation. As such, investors need to be cautious and carefully evaluate their financial situation and risk tolerance before deciding whether to invest in crypto.

It's difficult to evaluate or value

Unlike stocks, cryptocurrencies are not tied to a company's financial health and viability. They are not corporations but digital currencies that represent value or assets within a network. Their value is not based on revenue generation but on the participation of the community.

The crypto space is still in its infancy, with most cryptocurrencies in the development stage. This means there is a limited number of real-world use cases and a lack of track record to evaluate.

Arbitrary Pricing

Cryptocurrency prices are entirely arbitrary and only reflect the crowd's best guess at any given time. This guess can change very quickly, making it difficult to evaluate or value crypto.

No Standard Evaluation Method

There is no standard way to evaluate cryptocurrencies like there is with stocks. For stocks, fundamental analysis involves looking at a company's financial statements, but this is not possible with crypto.

Volatility

The crypto market is highly volatile, making it challenging to evaluate the value of a cryptocurrency.

Lack of Regulation

The lack of significant regulation in the crypto space means that investors are exposed to a higher level of risk, including the risk of fraud, lack of transparency, and potential digital theft.

Scarcity

Scarcity, or the finite nature of coins, can also impact their value. A fixed supply of an item will generally increase its value over time, assuming demand increases. This creates scarcity and can drive up prices.

Community Engagement

The success of a cryptocurrency depends on the engagement of its community. A more active community can indicate greater acceptance of the ideas and functions of the cryptocurrency, which can lead to greater success and impact its value.

Tokenomics

Tokenomics refers to the design and framework of a token or cryptocurrency. A well-designed token should be able to resist inflationary pressure, have utility in its ecosystem, be fungible, store value, and incentivize its use. Evaluating the tokenomics of a cryptocurrency can help determine its potential value.

Market Metrics

Pulling market metrics such as market capitalization, trading volume, and supply can also help evaluate a cryptocurrency's value. However, it is important to consider multiple factors together as relying on market cap alone is not recommended.

White Paper

Reading the crypto white paper is an important evaluation tool. This document outlines the intentions and utility of the project and how the token will interact with the blockchain ecosystem.

Team Credibility

Assessing the credibility and experience of the team behind a cryptocurrency is essential. It is important to research the team members' experience and track record to predict how far the project can go.

Social Media Presence

As social media plays a significant role in the crypto space, a company's overall social sentiment can aid in research. Checking their presence on platforms like Twitter, Reddit, and Discord can provide insights into their engagement with followers and the sentiment around the project.

Price History

Studying the price history of a cryptocurrency can help identify potential scams or rug pulls. For example, exaggerated highs immediately followed by lows may indicate a "pump-and-dump" scam.

Token Distribution

Reviewing the blockchain transactions of a network can help identify potential future market manipulation. A large distribution of tokens among a network's founders could be a red flag.

Real-World Adoption

Widespread adoption of a cryptocurrency is necessary for it to gain long-term value. Currently, very few cryptocurrencies are widely accepted for the purchase of goods and services, which can impact their value.

Expect brutal volatility

Crypto is a highly volatile asset class. Volatility refers to the rate at which the price of an asset increases or decreases over time. Generally, the more volatile an asset is, the riskier it is considered to be as an investment. Crypto's volatility is in a league of its own compared to traditional markets.

Cryptocurrencies like Bitcoin and Ethereum have experienced significant upward and downward movements over short periods. For instance, Bitcoin has witnessed over eight 50% corrections in its 15 years of existence, with drawdowns of as much as 40% from peak prices. These steep sell-offs can shake out even the most resolute investors.

The crypto market's immaturity and small size contribute to its volatility. As a relatively new asset class, crypto is still in its price discovery phase, with new participants constantly entering the market. The market is also fragmented across many exchanges, making it challenging for large players to enter or exit without affecting prices.

The distribution between supply and demand further exacerbates volatility in crypto. The limited supply of certain assets, like Bitcoin, can lead to substantial upward pressure on prices when demand increases. Additionally, large holders, often called "whales," can significantly impact prices by buying or selling large quantities of a particular asset.

Investor sentiment also plays a crucial role in crypto volatility. The crypto market, dominated by individual retail investors, is susceptible to the spread of positive or negative views, leading to reflexive feedback loops that drive up demand and cause major price movements.

While crypto's volatility may appeal to some investors seeking high returns, it is essential to recognise the risks associated with these volatile assets. The potential for substantial gains comes with the very real possibility of substantial losses.

There's very little regulation

The cryptocurrency market is a largely unregulated space, and this lack of oversight can lead to significant risks for investors. Without regulatory bodies monitoring the industry, there is little protection for investors if things go wrong. For instance, if you lose your crypto investment due to fraud or a hack, there may be no way to recover your losses.

The lack of regulation also means that crypto exchanges and companies can operate without fear of repercussions, even if they are not complying with existing laws. This can lead to issues of non-compliance and aggressive actions against digital currency firms, as seen with the US Securities and Exchange Commission (SEC). The SEC has been enforcing existing securities laws on crypto firms, but the industry argues that crypto should be treated differently due to its unique nature.

The crypto industry's call for clearer rules has been met with some sympathy, with the argument that the SEC is simply operating within existing regulations and that it is up to governments to create new laws. However, the lack of clear regulation in some countries, like the US, could see them fall behind other jurisdictions that are more crypto-friendly, such as Switzerland and Dubai.

The absence of significant regulation also impacts the stability of the crypto market. Without regulatory measures to curb price volatility, investors are exposed to brutal volatility and steep sell-offs. This can cause even the most resolute investors to be shaken out of their positions, leading to substantial losses.

To address these concerns, global regulators are urged to act quickly to strengthen financial regulation and supervision in the crypto space. This includes licensing and registering crypto-asset service providers, imposing prudential requirements on stablecoin issuers, and developing global standards that can be consistently implemented by national regulatory authorities.

It's prone to illegal activities

Cryptocurrency is prone to illegal activities due to its anonymous, decentralised, and unregulated nature.

Firstly, cryptocurrency transactions are anonymous. While blockchain transactions are recorded on a public ledger, the identities of the individuals involved remain unknown. This allows criminals to seemingly anonymously trade drugs, weapons, explosives, and child pornography, as well as fund extremist organisations.

Secondly, cryptocurrency transactions are peer-to-peer, with no need for a third-party mediator. This lack of oversight is exploited by criminals for one-off sales of illegal goods and services, such as drugs, digital data, and terror funding across borders.

Thirdly, cryptocurrencies are easily accessible and transferred. Anyone with an internet connection and a digital wallet can transfer money anywhere in the world within minutes, without the delays associated with traditional banking systems. This ease of access and transfer enables criminals to both steal and launder funds quickly and internationally.

Additionally, the decentralised nature of cryptocurrencies means they are not subject to significant government regulation or oversight. This lack of regulation makes it difficult to combat cryptocurrency-based crimes and provides little protection or recourse for victims of fraud or theft.

Finally, the anonymous and decentralised nature of cryptocurrencies makes it challenging for law enforcement agencies to detect and investigate illicit transactions, identify the parties involved, and bring them to justice.

While the growth of legitimate cryptocurrency usage is outpacing the growth of criminal usage, the increasing dollar amount collected through cryptocurrency-based crime remains a significant concern, creating impediments for continued adoption and heightening the likelihood of restrictions by governments.

It's not a legal tender

The most significant drawback of investing in crypto is that it is not a legal tender. This means that, unlike traditional currencies, it is not recognised by governments and financial institutions as a valid means of payment for goods and services. While some countries like El Salvador and the Central African Republic have granted Bitcoin legal tender status, the majority of nations have not followed suit. The International Monetary Fund (IMF) has advised against granting cryptocurrencies legal tender status, citing potential risks to monetary stability and policy.

The lack of legal tender status for crypto has several implications. Firstly, it means that crypto is not widely accepted as a means of payment, even in countries where it is legal. This limits its usefulness as a currency and can make it difficult to use in everyday transactions. Secondly, the absence of legal tender status can create regulatory and tax complexities. The tax treatment of crypto varies across countries, and in some cases, it may be subject to higher tax rates than traditional currencies.

Additionally, the decentralised nature of crypto means that it is not backed by any central bank or government, resulting in a lack of consumer protection. The extreme volatility of crypto prices can lead to significant wealth losses for households and businesses. Moreover, the anonymous nature of crypto transactions can facilitate illicit activities such as money laundering, terrorism funding, and tax evasion, posing risks to a country's financial system and relationships with foreign entities.

Lastly, the widespread adoption of crypto as a national currency could have dire ecological consequences. The mining of cryptocurrencies like Bitcoin requires a massive amount of electricity, impacting the environment negatively.

Frequently asked questions