SHOULD YOU INVEST IN CRYPTOCURRENCY?

When Bitcoin hit $20,000 in December of 2019, Cryptocurrencies made their debut in the mainstream world’s eyes. Cryptocurrencies have existed for a while with bitcoin being considered the first decentralized cryptocurrency created by a group of programmers in 2009. There is a lot of discussion about the use of cryptocurrencies as an investment class, here are a few things you should know before you decide to take the digital plunge.

What are cryptocurrencies?

Cryptocurrency is decentralized digital money, based on blockchain technology. Now, what is a blockchain? A blockchain is akin to a small ledger that records all transactions in code. Transactions are recorded in “blocks” that are then linked together on a “chain” of previous cryptocurrency transactions. An important feature of cryptocurrencies is that they are decentralized, not issued by a government body, and unregulated, which makes them immune to government interference.

Blockchain technology is relatively new and has the potential to disrupt many industries with its widespread application. This technology can have an effect similar to digitalization in the next 10-15 years. Crypto coins (like Bitcoin, Ether, Dogecoin, etc) are based on this technology. But are crypto coins– which have no revenue, no practical uses, and high volatility - a rational investment choice?

Bitcoin, Ether, and Dogecoin might be some of the names you’ve heard before in the crypto sphere, but there are over 5000 cryptocurrencies currently being traded. There are several reasons why one would want to invest in cryptocurrencies. Here are a few points to take into account before you decide to invest your hard-earned money into crypto tokens:

1. Higher Risk doesn’t mean higher return but a wider return range: There is a huge difference between higher return and wider return range. People generally get confused and the media has blurred the difference between the two. Let’s see the graph given below. The linear line shows that your returns increase with the units of risk taken. We have assumed a straight line for simplicity of understanding. At every point, we have shown the expected return range depending on the market cycle, economics, and a multitude of factors.

As you take more risk, your chance of an adverse outcome or major losses increases. Cryptocurrency falls at the further end of the spectrum. As an investor, you have to understand whether a large amount of risk is worth taking. Do you have the ability to take that much risk?

2. Emotional or FOMO (Fear of Missing Out) based decision – Media covers only selected crypto coin's success stories and ignores the negatives or failures. Thus, it gives a biased positive view and a false high return expectation from a crypto coin portfolio. By human nature, the anticipation of rewards releases a flood of dopamine (pleasure chemical of the brain), which primes us to become sloppy and undisciplined; success begets failure. Furthermore, positive emotion leads us to overstate the likelihood of positive occurrence. This coloring of probabilities leads us to misapprehend risk.

3. Cryptocurrencies are unregulated: Most cryptocurrencies traded are unregulated, this means that there is no entity like a central bank such as the RBI or the Federal Reserve or regulatory authority such as SEBI or the SEC that they are answerable to. If you encounter fraud or if someone scams you of your tokens, the money is impossible to get back. There is no grievance redressal authority that you can contact for help. Legality is also another grey issue. For cryptocurrency in India, although they are not considered illegal and There are avenues where you can buy and trade them on platforms such as coinswitch and bitbns, they are not recognized as “currency” by the RBI, which caution traders to proceed with these transactions at their own risk

4. Fragile Reasons for Price Growth: Main reasons for the price movement are due to:

1. Supply-demand gap but most demand is speculative in nature and pseudo shortage of coins.

2. Public interest in Bitcoin which is mostly driven by positive media reports, over-enthusiastic influencer, and a recent surge in price

3. Political and Regulator news depends on Sovereign Government reaction or acceptance to the use of cryptocurrency.

All of the reasons are not driven by solid economic logic

5. Incomplete or lack of information: Transparency may be one of the tenets of cryptocurrency but the technology backing it is not the easiest to understand. This leaves you open to outside risks such as falling victim to Ponzi schemes or fraudulent tokens. With virtually nowhere to report these crimes, your money is lost forever. We tried to find how these coins came to be in the last 5 years and how many still exist, but there is no data. It is a wise saying that you should only invest in things that you understand and it might be best to stay out of such a high-risk instrument if you don’t understand it fully.

Due to a lack of information, such a system may see breaches of financial crime laws. Other than its trading concerns, the mining of cryptocurrencies requires massive amounts of energy. The mining process itself, the abundance of computers used for mining purposes, and their cooling all put extraordinary pressures on the environment. Some governments have already explicitly banned them and these concerns may incentive may others to follow suit. All of these put together is why the future of investing in cryptocurrencies is filled with risk and uncertainty.

The feasibility of cryptocurrency as a mainstay is still debatable and the verdict is still not out. However, there is no denying that cryptocurrencies have components that are extremely desirable in any investment. From anonymity to cutting-edge blockchain technology. This is also a constantly evolving space with organizations going out on a limb to support this investment. More recently a proposal has been mooted to peg a cryptocurrency to a unit of USD or Gold. Thus this space is constantly evolving and could look completely different in a couple of years.

Stay tuned to this site as we track the changes and opportunities as they fructify.

Also, see our views on Active Vs Passive Investment? What to do? - Click Here.

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