These days, when investing, it is hard to ignore a relatively new asset class: cryptocurrency. In 2009, Bitcoin was established, paving the way for a whole raft of other cryptocurrencies that offered a fresh way to invest funds and build wealth. But, Bitcoin and its peers have come under intense scrutiny this year. Some market commentators are claiming that crypto is dead. But is that true? And what does such a claim mean in practice, particularly for those who have already invested in digital currencies? Is cryptocurrency an asset worth investing in?
By knowing the pros and cons of cryptocurrency as a potential investment, you can decide whether it is suitable for you in light of your circumstances.
Potential benefits of investing in cryptocurrency
While cryptocurrency may be daunting to some, given its relatively recent inception, there are potential benefits to investing in it.
Cryptocurrency is decentralised, meaning no single government or any other governing body oversees it. Instead, blockchain technology renders it as transparent as possible. The result? Investors are not subject to international transaction costs and exchange rates. It also means that cryptocurrencies are not beholden to changes in government policy or, indeed, changes in government. As a result, they are not affected by inflation or deflation.
Volatility and returns
Ordinarily, volatility is something many investors would prefer not to have to experience. However, it can be advantageous. Speculators have long used volatility to make returns by selling and buying assets quickly to profit from rises and dips in the market. Volatility most definitely characterises cryptocurrency markets. The peaks and troughs of Bitcoin and its peers can provide a speedy way to make some serious returns. However, you have to be able to time your entries and exits to the market flawlessly. If you don’t, you can stand to make significant losses.
Asset allocation and diversification
Cryptocurrency can be an effective way to help diversify your portfolio. Crypto is often argued to be weakly correlated to traditional investments like stocks. MarketWatch recently found, for example, that Bitcoin had a correlation of 0.03% to the S&P 500 index. One of the main reasons for this is that digital currencies are decentralised. That means they are not beholden to broader government policy or economic impacts, like inflation, as stocks or bonds are. That means the rises and falls of crypto are dependent on other causes.
For example, Bitcoin had a volatile few months when Elon Musk tweeted his thoughts on the e-currency. The market cap of Bitcoin plunged when Musk later announced Tesla would no longer accept Bitcoin as payment. Tesla has since reinstated this payment type. But the initial news sent the price of Bitcoin, and many other cryptocurrencies, tumbling. In contrast, stock markets were unaffected by Musk's tweet.
Potential drawbacks of investing in cryptocurrency
Every asset class has disadvantages that can make them a riskier investment than you may like. It is best to make investments with your risk profile at the forefront of your mind, along with your portfolio's structure.
For some, cryptocurrency's volatility makes it a desirable proposition. To many, however, the risk that comes with high volatility is too much. Volatility makes it difficult to predict any price rises and losses. If a price is constantly going up then dipping significantly, it can be difficult to ride out long term volatility that can eventually result in gains. Plus, it simply makes it far trickier to time your exit to receive the optimum return.
Cryptocurrencies were developed independently from one another. As a result, it can be challenging to exchange one crypto for another. That can make it a less attractive asset class as the transactions sometimes needed to change one currency to the other are often inefficient. That said, there are platforms where Crypto holders can exchange their tokens and coins with other platform users. However, at present, it is not always as easy as it would be to sell stocks or to exchange traditional currency.
Just as volatility can be both an advantage and disadvantage for investors, the decentralised nature of crypto can bring risks. If something is decentralised, it is unregulated. No regulation makes an asset class riskier to invest in as market users may seek to exploit the lack of oversight. That is not the case when investing in stocks and bonds - markets subject to considerable regulation. Such regulations make these markets a safer place to grow wealth while allowing investors to be confident they won't lose their money in a scam. While cryptocurrency is not a scam, the lack of regulation does pose uncertainty that traditional assets do not have.
Recently, there was a hack on Poly Network, where cryptocurrency holders can exchange different types of e-currency for another. And that is one of the most significant risks associated with investing in cryptocurrency. It is such a new technology relative to other asset classes that it attracts cybercriminals looking to exploit vulnerabilities. While cryptocurrency is an exceptionally complicated technology to hack, cybercriminals can be highly intelligent and motivated. The latest heist on crypto by hackers demonstrates just that. Hackers managed to steal $600m worth of crypto. And, there was little that those at Poly Network could do as crypto is decentralised.
Can crypto be shut down?
In short, no. Crypto cannot be shut down. The reason being is that it is a public ledger and form of technology that means that it cannot be stopped. That said, governments - especially powerful governments like the US and China - can regulate it. And they can regulate it so that many of its advantages are no longer unique to this asset class. Its decentralised nature makes it a desirable proposition for many investors, especially those that do not trust governments and their intervention in capital markets.
And governments are trying to regulate it more. The Chinese government, in particular, has implemented many policies and rules that have had material impacts on how cryptocurrency can be bought, sold and used by the population. While that may make it a more attractive investment class for some, it does mean that cryptocurrency starts to lose some of its appeal. For many, the fact that it is decentralised is its main attraction.
Is it safe to invest in cryptocurrency now?
Given the latest hack and the absence of Government oversight on digital currencies, is it a safe and investable asset class? For the most part, yes, it probably is. While digital currencies have suffered from hacks from cybercriminals, traditional investments also bring risks. Companies listed on stock exchanges, for example, can go bust. They can be subject to huge fines by governments if they break the law, impacting their stock price. That is a possibility for many companies - though thankfully not a common occurrence. But the same can be said for cryptocurrency.
Plus, you have to calculate whether you think it is safe to invest in terms of return. While some digital currencies have high market caps and have seen significant price rises, many are worth little more than $1. So you have to make an informed decision as to whether you think a digital currency can or will gain in value. That is, of course, an investment question that you have to ask of all potential investments. Some digital currencies will likely not rise in price at all.
And, as stated above, crypto is starting to be more regulated by some Governments. Given that one of those Governments is China, that may make it a safer asset class, as cryptocurrency may not be utilised by some investors who buy it for less than legal purposes.
So, is crypto dead?
Crypto is not currently dead and does not look like it can, would or should ever be shut down. Still, two elements to it may make it a dead investment class to you. Firstly, you may not find the risks of crypto worth taking. Arguably, it is a riskier investment asset than other traditional classes.
And, it may be even less appealing to you if one of its main attractions is its lack of regulation and decentralised nature. At present, the trend looks like increased regulation of the area will continue. What that means for how the asset class develops will be interesting to see. Whether it means increased adoption and further usage in day to day life or whether it becomes far less popular for investors could be argued either way at present.
While crypto is not dead, it remains a contentious investment class for many reasons. But, that is the case with any asset. For an asset to be sold, there must be a seller who no longer wants it due to the risks and disadvantages associated with that particular asset. For it to be bought, there must be a buyer who believes the potential gains outweigh the risks. That is the very nature of all capital markets. It's just that cryptocurrency currently seems to be grabbing a great deal of media attention. Drown out all that noise, drill back to the fundamentals and ascertain whether it is a good investment for you, based on your specific circumstances.