These days, when investing, it is hard to ignore the hype around 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 through the crypto market. But Bitcoin (BTC) and other altcoins like Ethereum (ETH) and Stablecoin (SBC) have come under scrutiny as crypto values have crashed far from the all-time high Bitcoin and others achieved in November 2021. As a result, some market commentators are claiming that crypto is dead.
But is that true? What does such a claim mean in practice, particularly for those who have already invested in digital currencies? And is cryptocurrency still - or was it ever - an asset worth investing in?
Knowing the pros and cons of cryptocurrency as a potential investment can help you decide whether it is suitable for you in light of your circumstances - whether in a bull or a bear market.
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.
The entire cryptocurrency ecosystem is decentralised, meaning no single government or 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 or at a country’s central bank. As a result, they are not affected by inflation or deflation.
Volatility and returns
Ordinarily, volatility is something many investors would prefer not 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 must be able to time your entries and exits to the market flawlessly. If you don't, you can stand to make significant losses.
Some investors try to get around this problem by investing in stablecoins or even algorithmic stablecoins. Stablecoins are pegged to traditional currencies like the US dollar (USD), so they should be less volatile. However, that lower volatility is compared to other digital currencies, not conventional investments.
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 found, for example, that Bitcoin only 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. As they are not as affected by broader government policy, they do not always feel economic impacts, such as inflation, like stocks or bonds. That means the rises and falls of crypto are dependent on other causes.
For example, in 2021, 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, although 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. Therefore, it is best to make investments with your risk profile and your portfolio's structure at the forefront of your mind.
For some, cryptocurrency's volatility makes it a desirable proposition. To many, however, the risk of high volatility is too much. Volatility makes it difficult to predict any price rises and losses. If a price constantly goes up and then dips significantly, it can be difficult to ride out long-term volatility that can eventually result in gains. Plus, it makes it far trickier to time your exit to receive the optimum return.
You don't need a Bloomberg terminal to see the vast peaks and troughs that cryptocurrencies have been through in the recent past. Just type in TerraUSD or any other cryptocurrency into Yahoo Finance, and you'll see the bumpy road its price has taken in 2022 alone.
Cryptocurrencies were developed independently from one another. As a result, it can be challenging to exchange one cryptocurrency for another, even with the rapid development of platforms such as Binance. That can make it a less attractive asset class as the transactions sometimes needed to change one currency to another 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 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. Having 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.
All types of crypto exchange and crypto assets are a target for cyber hacking. It is such a new technology relative to other asset classes that it attracts cybercriminals looking to exploit vulnerabilities. While cryptocurrency can be challenging to hack, cybercriminals are often highly intelligent and motivated. For example, in August 2021, hackers managed to steal $600m worth of crypto through an attack on Poly Network, a platform where cryptocurrency holders can exchange e-currencies. Perhaps most worryingly, there was little that those at Poly Network could do, given that crypto is decentralised.
Can crypto be shut down?
In short, no. Crypto cannot be shut down because it is a public ledger and form of technology, so it cannot be stopped. That said, governments - especially powerful governments like the US and China - can try to regulate it to a certain degree. And they can regulate it so much that many of its advantages are no longer unique to this asset class or other digital assets like NFTs.
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 as it could be deemed safer, to some, it may 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 chance of being hacked and the relative absence of Government oversight on digital currencies, is it a safe and investable asset class? For the most part, yes, it probably is. However, while digital currencies have suffered from hacks by cybercriminals, traditional investments do 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 now have high market caps and have seen significant price rises, many are worth little more than $1. Some digital currencies will likely not rise higher in price at all. So you have to decide whether you think a digital currency can (or will) gain in value and rankings. That is, of course, a question you must ask of all potential investments.
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 cease to be used by investors who buy it for illegal purposes. Plus, more crypto wallets are being established - both hot and cold. As the technology develops, holding a digital asset portfolio should become easier and safer as time goes on.
So, is crypto dead?
Crypto is not dead. Nor does it look like it can, would or should ever be shut down. Still, two elements may make it a dead investment class for you. Firstly, you may not find the risks of crypto worth taking - it is arguably a riskier investment asset than other traditional classes.
And it may become less appealing to you if one of its main attractions is its lack of regulation and decentralised nature. At present, it 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.
Ultimately, while crypto is not dead, it looks set to remain 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, a buyer must believe 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 based on your specific circumstances.