The Risk of Investing in Cryptocurrencies

by: Tam Ging Wien

Just like any other investments, an investor also takes on risk when getting involved in cryptocurrencies. 

We are ProButterfly certainly encourage the public participation in cryptocurrencies, but we would also like to caution our readers with regards to the risk that they are taking on.

Here are our list of top cryptocurrencies risk that all investors should be aware of.

1. Cryptocurrencies Have No Intrinsic Value

Cryptocurrencies are similar to fiat currencies that they have no intrinsic value. The value of a coin is simply governed by simple demand and supply mechanics; it derives its value simply based on what the market is willing to pay for it. So long as people continue to trust in a particular coin and its acceptance continues to gain traction, its value will hold or increase. However if people lose faith in the particular coin, it will lead to poor acceptance and finally its demise rendering is valueless.

Cryptocurrencies also have no intrinsic function other than as a medium of exchange, unlike gold, silver, oil, wheat or cotton which have industrial uses. Therefore unlike physical commodities, crytocurrencies being virtual commodities can be used for any other purpose which restricts is demand.

2. Cryptocurrencies Generally Do Not Have Productive Value

Cryptocurrencies are designed to be a medium of exchange and it is itself a form of commodity. Commodities in general do not have productive value as the asset itself can be difficult to put into productive use to earn income.

The concept of banks in the cryptocurrency world is also somewhat limited at the moment. There is few entities out that that will pay you an interest for your coin deposits.

One can only profit from cryptocurrency by capital appreciation or trading it short.

3. Cryptocurrencies Are Highly Volatile

Cryptocurrencies are traded on the open market and are therefore susceptible to market fluctuations. As adoption of cryptocurrencies are still is very early stages, their value is can be swing in either direction very wildly.

Also due to the international nature of cryptocurrencies, they trade 24 hours a day, 7 days a week. Therefore it is impossible for any one individual to monitor and make fast decisions should any of their coins experience a flash crash. A crash could occur while the individual is sleeping or have no access to the internet to react.

The high volatility and international nature of coins is simply a risk that all coin owners need to live with.

4. Cryptocurrencies Stored Can Be Lost or Misplaced

All cryptocurrencies are designed to be stored against a public ledger which tracked its balance. Each of these virtual addresses or accounts have a corresponding private key which is required to release the funds in the account. Therefore losing the private key will result in the coins in the corresponding account going dormant as nobody is able to find the private keys to spend those coins. This will result in fewer coins in circulation and potentially increase the demand and value for the coins in circulation.

The coin addresses also do no store personal information, therefore there is nothing linking your ownership to a particular coin address. The only proof of ownership is the possession of the private key. Should your private keys be stolen, the thieve is able access and withdraw your coins. And there is no recourse for you to get those lost coins back.

Ensure that your private keys and wallets are backed-up regularly and stored in multiple backup devices. Ensure that your backup devices are stored securely to prevent such losses.

5. Cryptocurrencies Stored on Exchanges and Online Wallets Are Vulnerable to Hacks

As your coins need to be accessed by the online coin exchanges and wallet services, a copy of the corresponding private key will be stored with them. Therefore if these online services are compromised, an attacker could gain control of those private keys and quickly transfer large amounts of coins out of the exchange. In early 2014, Tokyo based Mt. Gox exchange was hacked with over BTC 750,000 transferred out. In a similar event in August 2016, Bitfinex had also lost about BTC 120,000 to cyber thieves.

The only save place to keep your coins away from these cyber thieves are to store your private keys offline away for these exchanges. Even then, they could be physically stolen or lost.

6. Cryptocurrencies Transactions Are Irreversible

By design, the blockchain that enables the transactions of cryptocurrencies are secure, anonymous, irreversible and resistant to modifications. As a result, errors in cryptocurrency transfers are also irreversible. In the event that you transferred your coins to the wrong address or made and error in the transfer process, the coins may be permanently lost. The onus lies with you to ensure that all entries and steps are correct before a transfer takes place.

7. Impossible to Keep Track of All Cryptocurrencies

It is estimated that there are more than 2000 unique cryptocurrencies in circulation today each with its own unique features. New ones are being created on a regular basis and circulated quickly in the markets through ICOs. Therefore, it would be almost impossible to keep track of the benefits and risk of each of these coins. It also makes it difficult to predict which coin will eventually succeed and gain widespread adoption and which will fall out of favour.

Various news sources and media could also quickly sway public opinion on which coins to favour.

The current financial system is not able to support such a large number of coins and in the coming years, majority of these coins will likely fall out of favour and died a natural death.

Therefore for early investors and adopters of cryptocurrency, it would be wise to diversity your coin holdings to manage the systemic risk. A basket of cryptocurrencies is more likely to preserve its value in the long run than putting all your bets on one single coin.

8. No Clear Regulations Governing Cryptocurrencies

As cryptocurrencies are designed to be decentralized without a trusted entity, there is no central governing authority to regulate them. Therefore owners of coins have no legal recourse should any fraud, accidents or negligence happen to them.

9. Cryptocurrencies Could Be Restricted By Jurisdiction

For every emerging technology, there will always be supporters and opponents. Nations choose to embrace the technology will recognise it and put regulatory controls to govern how, when and what it can be used for. On the other hand, nations that oppose the technology could outright ban its use, take legal action against users or force its citizen owners to surrender their holdings in a compulsory confiscation.

In April 2017, Japan recognised Bitcoin as legal tender becoming the first nation to do so. Japan’s recognition of Bitcoin has made other nations consider the potential and risk of cryptocurrency more seriously. To add to this, Bitcoin has a history of being used for illicit trades such as money laundering and payments for illegal goods such as drugs, weapons, prostitution and ransom. Fearing its wide spread adoption and anonymity, governments will likely impose regulations to curb its criminal use.

Governments may also choose to invent their own cryptocurrency and ignore other generic forms. For example, the Royal Canadian Mint created MintChip which is a form of cryptocurrency which is held on a smartcard but backed by the Canadian dollar.

All these will create uncertainly within the cryptocurrency space leading to more volatility in its value.

At ProButterflyTM, we encourage all our readers and subscribers to dabble a little into the cryptocurrency space as we believe that asset class has a long term potential and the wave has only just started. We encourage you to read our introduction to blockchains and cryptocurrencies as the following links:-

 

Close

50% Complete

Investment Newsletter

Subscribe for our exclusive weekly newsletter. We do not share that content on the blog. It includes in-depth analysis on equities, IPO's & REITs. Join our exclusive inner circle today and get an edge in your investing!