As an investment option, cryptocurrency provides a number of unique challenges and opportunities that should be considered before purchasing. You have probably heard a lot about cryptocurrency, blockchain, and other technical jargon around the subject of crypto. It is complicated.
Cryptocurrencies are virtual currencies secured by complicated programs. From an investor standpoint, it is an asset that has value based on the price other people are willing to pay for it. Crypto pricing operates similarly to any foreign exchange (forex) market.
Many investors can make money without ever understanding how a particular cryptocurrency works or about the blockchain. They instead focus on the cryptocurrency markets.
Pros and Cons of the Technology of Crypto
The technology behind cryptocurrency is complicated and often a bit of a black box for those who are not experts. Each coin has its own blockchain, its own rules, and any other technology or other developments they have tied to it. It can be hard to keep up.
Despite these differences, whether you are dealing in Bitcoin or altcoins — a collective name for all cryptocurrencies other than Bitcoin (and sometimes Ethereum) — all cryptocurrencies have some basic similarities behind them.
Pros of Cryptocurrency Technology
Other than the various scams that fool individual investors into parting with their coins, the focus of most conversations about the security of cryptocurrencies is the underlying technology for mining and exchanging the assets.
Bitcoin was designed to be an absolutely secure system, and most currencies have gone on to continue most of the best practices that this first mover demonstrated. The decentralized register that underpins blockchain technology means that if someone were to attempt to hack a cryptocurrency to modify a record or falsify a transaction, they would have to hack the majority of computers involved in the cryptocurrency.
Without doing this, the rest of the register would just correct whatever the hack was. Potential hackers need a majority order to “convince” the system that the fake record was legitimate. In terms of resources, this is unrealistic. To date, there has not been a single successful attack on the Bitcoin network.
2. Mining Is Accessible to Anyone
An advantage of cryptocurrency is there is no barrier to stop you from getting involved. With a few Internet searches, you can set up your computer to start mining coins for you.
With Bitcoin, you are unlikely to make any money mining without a gargantuan rig, but on some lesser-known coins, you might be able to set up your computer to generate some extra money for you without you doing a thing.
Cons of Cryptocurrency Technology
1. Imperfect Security of Wallets and Exchanges
The weak point in cryptocurrency’s security is with the user. Although the Bitcoin network itself remains unhacked, a number of the surrounding software tools that interact with the network have been infiltrated and misused.
If someone gets into your cryptocurrency wallet, they can steal your coins. That has nothing to do with the security of the cryptocurrency as a whole. The same goes for if a trading exchange is hacked — you could lose out big through no fault of your own.
Exchanges are the platforms that serve as the easiest way to trade different cryptocurrencies, analogous to the app or platform you’d use to buy and sell stocks. If a hacker is able to send a directive to the exchange to conduct a transaction, they do not need to hack the cryptocurrency. Instead, their fraudulent order will read as a legitimate transaction and will be accepted by the rest of the blockchain.
This is famously what happened to Mt. Gox, a cryptocurrency exchange that operated from 2010 until 2014, when a hacker was able to pose as an auditor for the site and authorize transactions. Accounts with more than $8 million in Bitcoin were affected.
Many companies hide or downplay the disclaimers around this. As a result, the supremely secure Bitcoin network isn’t worth a hill of beans if the surrounding infrastructure is full of holes.
2. No Recourse for Digital Asset Recovery
There are tens of thousands of dollars of real money locked in computers because the owners do not know how to recover them. Maybe they forgot a key password, or maybe they forgot that they have a couple of Bitcoin they once bought as a joke.
Once you take your cryptocurrency off a trading platform and into your own control, you are the sole person responsible for it. If you lose your private keys, the coins are gone for good. If your coins are stolen, there’s no way to track them down and generally no recourse for recovering them.
If the company that holds your coins has something happen to them, there is no guarantee that you will be able to get your money back. Banks have insurance that can protect your funds in case they fail. Stock markets have regulations that prevent a number of shady dealings from going on, and brokerages carry insurance in case they fail as well.
There’s no such protection for crypto brokers or exchanges. The lack of regulations in cryptocurrencies means that if you are not careful, you may be the one left holding the bag.
3. Mining Coins Requires Serious Resources
Making serious money from mining requires a commitment of time and money. You will need to prepare a serious set of hardware, with many creating specialized computers or servers for the task. Even then, you need to pick a coin that you can make money off of, instead of never realizing your investment.
4. Overpromising Based on the Blockchain
Blockchain technology is relatively new and hard to understand. As a result, it is often marketed as a modern-day snake oil that can cure all ills. Some fraudsters have argued that their new technology based on the blockchain will replace credit cards or reshape an industry, only for them to disappear with investors’ money.
Even well-intentioned people with big ideas for using the blockchain can get investors into trouble. Several companies and celebrities have announced plans to create their own coins or other products based on the blockchain, but the viability of any of these ventures remains to be seen.
If an investment opportunity that makes big promises based on “blockchain technology” sounds too good to be true, it may well be.
Pros and Cons of Investing in Cryptocurrencies
Any time you invest money, you are putting it at risk. Bitcoin trading is in many ways like trading a currency or a stock. You are trying to buy at a lower price than you eventually sell at.
Stocks have intrinsic value and dividends that they can give you, and U.S. dollars and other major currencies are backed by central banks. But there aren’t the same tethers for cryptocurrencies.
This contributes to cryptocurrencies’ high levels of volatility. They can be good as either a short-term investment or a long-term one, in the right hands.
Pros of Investing in Cryptocurrency
1. Price Fluctuations Can Create Huge Profits
The value of a coin is determined based on how rare it is, the effort expended mining them, and the characteristics of a particular coin.
In the course of a single month, a virtual currency can move by over 20% in its value. In normal years, stock trading can see similar changes, but it is less as common. Making real money is entirely possible in this environment, but it also means that you can lose a lot with just one small mistake. Prices can have huge swings from any mention of a specific coin on social media, leading to huge price swings.
Some, like teenager Erik Finman, were able to buy in early; he bought into Bitcoin in 2011 and managed to turn $1,000 into $1,000,000 over the course of five years on the currency’s early rise to popularity.
Independent trader Javeed Khan got into Bitcoin in 2018, making a few hundred thousand dollars in profits in his first year, showing that solid profits are still achievable even on an established coin’s price swings.
2. Behaves Like Currency
Treating cryptocurrency trading as though it were a currency in terms of your investment approach may prove to be the most useful analog. Many forex — foreign exchange — strategies can be effectively ported over to cryptocurrency trading, although you may want to note that the volatility of cryptocurrencies is significantly higher.
For example, Market Traders reports an average of 5% volatility for traditional currencies and up to 15% for cryptocurrencies. This, coupled with the relatively limited supply of available sellers for any cryptocurrency, presents a challenge that many investors will need to overcome.
3. Hedge Against Inflation — Maybe
Because each cryptocurrency has a limited number of coins, they are a natural hedge against inflation. Without the ability to print more coins, economic theory suggests over time the value of anything finite should keep up with rates of inflation. Cash in your savings account will often effectively lose value over time because rising costs mean the dollars saved today will be able to buy you less in the future.
Cryptocurrencies should not be subject to these changes, at least in theory. A word of caution, however: cryptocurrencies haven’t been around long enough to prove themselves as an effective hedge against meaningful real-world inflation the way gold and other “real” assets have, making this advantage more hypothetical than practical.
Cons of Investing in Cryptocurrency
Cryptocurrencies are volatile. It is hard to explain how volatile they are. As an example, businessman and entrepreneur Elon Musk mentioning reservations about Dogecoin, after initially voicing his support to the currency, threatened as much as a 70% change in price. Most of this discussion that sent Dogecoin prices on a roller coaster took place on Twitter in a series of tweets over the course of a week.
Making real money is entirely possible in a volatile trading environment, but it also means that you can lose a lot with just one small mistake.
Not being controlled by central banks means a coin’s value is whatever buyers on the open market will pay. But it also means there’s nothing tethering any cryptocurrency’s value to reality, and any coin could theoretically become worthless in an instant if demand for it goes away.
As with any investment, diversification is your best bet. Putting everything into a single coin or trying to win big in an initial coin offering (ICO) can make you a lot of money, or you could lose your shirt. Everything in cryptocurrency is high-risk, and you should behave accordingly.
2. Risk of Scams
Even the most legitimate seeming company in the cryptocurrency space is more volatile and at risk than those in other industries. And there are still many who hope to scam the unwary.
American technology company Ripple Labs Inc. developed and launched the digital currency XRP to allow financial institutions to use its Ripple payment/exchange network, aimed toward offering an alternative way to process day-to-day transactions.
Ripple offered what it claimed was a secure system of cross-border transactions. Their operations were based on XRP, and they hoped they would be able to take down SWIFT, the current system for most banking transactions. XRP joined the host of cryptocurrencies being traded on various cryptocurrency exchanges such as Coinbase.
The Securities and Exchange Commission (SEC) disagreed and filed suit against Ripple, claiming they had violated securities regulations. They argued that Ripple’s XRP was not a real cryptocurrency, and instead a way to functionally defraud investors.
3. Less Liquidity
Even the best cryptocurrency exchanges do not hold a candle to the liquidity that is tied to any stock market.
Institutional investors in more established markets create price walls by putting a lot of orders into the system at prices surrounding the current range of trading prices. This means a single big order tends to move the price less, as a lot of other automated trading happens around each big move.
In nearly all cryptocurrency markets, these price walls have not yet been established. A single large investor selling their crypto can cause a major swing in market prices as they go through filling the orders from the best price downward. This raises the volatility higher than it would be otherwise because sudden trades can lead to price shocks.
This risk piles atop the currencies’ existing everyday volatility to create further shifts in the market.
4. Changing Regulations
An area that needs to be watched is the changing laws around cryptocurrencies. In previous years, cryptocurrencies have been taxed at a relatively generous rate and governments have been largely hands-off.
Recent actions suggest that this time may be at an end, including President Biden tapping Janet Yellen — a noted cryptocurrency skeptic — as Treasury Secretary, the SEC filing suit against Ripple, and coin issuer Tether and the Bitfinex exchange paying $18.5 million to settle a legal dispute in New York. Together, these actions suggest regulators are skeptical of the industry.
New regulations may require reporting from either individuals or exchanges or even by the creators of certain coins. This may drastically change the market. Any market change can make or break fortunes in an evening.
It can be hard to determine which cryptocurrency is going to be a good investment. If we could tell you for certain, it would be easy to retire rich. It is best to treat cryptocurrencies like any fiat currency. There is no inherent value tied to any of them. All value is from the belief of the many people who buy into it. Anything that helps or hinders that belief changes the price.
In general, trying to catch a cryptocurrency on the way up is going to be nearly impossible. Instead, you should try to catch a currency that has a history of value in a lull — a time when fewer people are paying attention. Anyone hoping to make millions off the recent Dogecoin price movement has probably done so already. Jumping onto a new cryptocurrency that has little fanfare or backers is also a bad call — it could easily be worth fractions of a penny when no one is interested.
Your best bet is following similar fundamentals to any other investment — knowing your own risk and trying to make your own determination. If there is a lot of talk in the market about Bitcoin, maybe it is time to examine what Ethereum is doing. It might very well be the next one to hit a spike.
Blockchain technology looks as though it may be the next gold rush. As with all gold rushes, there are many who make money, and many who lose — and those who tend to do the best in a gold rush are often the ones selling pickaxes.
Investing in cryptocurrencies can help to pad your bank account, but realizing high gains will require work. In order to outcompete everyone else trying to buy low and sell high, you need something on your side. Maybe that is time spent doing research to plan each of your moves. Maybe it is a willingness to take an extremely long view, holding out through all the roughest periods during which everyone else sells.
Approaching cryptocurrency as part of your investment strategy can be effective, but should be tempered with patience and understanding. The high volatility of cryptocurrency means there are key strategies to help mitigate these challenges, but it also ensures this is a place where you can make a great deal of money.