Personal Finance

Why you must be cautious while investing in cryptocurrencies

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Summary

  • Some investors have created wealth with cryptocurrency, while others have had to contend with missed opportunities.
  • The word “cryptocurrency” is derived from the encryption techniques, which are used to secure the network.
  • To some, the excitement about cryptocurrency and blockchain is sort of like the dot com bubble where nobody in 2000 was quite sure what the Internet was all about.

The shocking rise of cryptocurrencies this past year triggered a wave of media attention on this new form of money as an alternative investment vehicle.

Some investors have created wealth with cryptocurrency, while others have had to contend with missed opportunities.

Some have called cryptocurrency an equaliser, bridging the gap between the rich and the poor. In its simplest form, cryptocurrency is a digital currency that is secured by cryptography, which makes it nearly impossible to counterfeit or double-spend.

The word “cryptocurrency” is derived from the encryption techniques, which are used to secure the network.

Many cryptocurrencies are decentralised networks based on blockchain technology.

Blockchains, which are organizational methods for ensuring the integrity of transactional data, are an essential component of many cryptocurrencies. They are fascinating new-age currencies only available online and allows the user to be somewhat anonymous.

To some, the excitement about cryptocurrency and blockchain is sort of like the dot com bubble where nobody in 2000 was quite sure what the Internet was all about.

Coin Offerings

The most popular cryptocurrency is bitcoin, but more than 10,000 different digital currencies are trading publicly.

Cryptocurrencies continue to proliferate, raising money through Initial Coin Offerings.

According to CoinMarketCap, the total value of all cryptocurrencies by August 2021 was more than $1.9 trillion.

Bitcoin accounts for 60 per cent of this with a value of $849 billion by August 2021 and an April 2021 high of $1.2 trillion. With this significant value appreciation in cryptocurrency, every investor would feel tempted to allocate some sizeable funds in these assets to earn some return, and there is nothing wrong with this thinking.

Every investor’s dream is to earn a fair return for every shilling or dollar invested. However, some believe investing in cryptocurrency is mere speculation and more like gambling. Some notable voices in the investment community have advised would-be investors to avoid cryptocurrencies.

Of particular note, legendary investor Warren Buffett compared bitcoin to paper checks: “It’s a very effective way of transmitting money and you can do it anonymously and all that. A check is a way of transmitting money too. Are checks worth a whole lot of money? Just because they can transmit money?”

Cryptocurrencies may go up in value, but many investors see them as mere speculations, not real investments. The reason being that just like real currencies, cryptocurrencies generate no cash flow, so for you to profit, someone has to pay more for the currency than you did. In other words, they have no intrinsic value.

Their only value being that someone buying after you is willing to pay more than you did. This school of thought calls this kind of investment “the greater fool” theory of investment.

Contrast that to a well-managed business, which increases its value over time by growing the profitability and cash flow of the operation.

Cryptocurrencies face further criticism for their use for illegal activities, exchange rate volatility, and vulnerabilities of the infrastructure underlying them. But, beyond those concerns, just having cryptocurrency exposes you to the risk of theft, as hackers try to penetrate the computer networks that maintain your assets. Those who see cryptocurrencies such as bitcoin as the money of the future must be reminded that a currency needs stability. Compared to most investments, bitcoin is a highly volatile, risky investment.

Historically, the price of bitcoin has spiked on several occasions, and then comes crashing down quickly. Bitcoin has in 2021 alone, experienced volatile price moves, reaching nearly $65,000 in April 2021 before losing nearly half its value in May. Bitcoin is currently trading in the $60,000 range.

Further, after rallying to nearly $20,000 in 2017, bitcoin’s price collapsed and lost a third of its value in a single day, and in 2018, it dropped to as low as $3,122, wiping out billions of dollars from the total cryptocurrency market value. While that can mean big returns, it can also mean big losses.

This attests to the speculative and volatile nature of all cryptocurrencies. Some believe bitcoin could reach the range of $100,000 to $200,000 in five or 10 years. With all the hype, many people are wondering if they should invest in bitcoin. But the cryptocurrency also creates a wide array of concerns, including fear of a bitcoin bubble, too risky to invest in or susceptible to fraud.

That is why some investment experts liken bitcoin to gambling and advise investing only as much money as you can afford to lose. You have to at least be mentally and financially prepared that a crash could happen again. Bitcoin has been exposed to several scams with some companies becoming bankrupt immediately after a scam is unearthed.

One of the scams unearthed in Kenya was around the app named Amazon Web Worker Africa, which claimed to be an affiliate of Amazon Inc. and was accessible via a mobile and web application. It had nothing to do with the global retail giant.

Investors in Amazon Web Worker woke up to find the app had been deleted from the Google PlayStore without official communication. Investments, some running into thousands of dollars, were rendered inaccessible.

The appetite for bitcoin Ponzi scheme-like kind of investment scams in Kenya may have something to do with the rate of unemployment. Pre-pandemic data from the Kenya National Bureau of Statistics show that 40 percent of youth lacked jobs in February 2020 and, with the pandemic in its 18th month, the employment situation is now even worse, making the jobless youth resort to any avenue to make ends meet. Jamie Dimon, JPMorgan Chase chairman and CEO, recently commented that bitcoin, the largest cryptocurrency by market value, is worthless.

Dimon also thinks regulators are going to regulate the value out of cryptocurrency. So far, digital currency is legal in the US, though China has banned its use.

Ultimately, whether they are legal depends on each country. As always, buyer beware.

The Central Bank of Kenya reiterates that bitcoin and similar products are not legal tenders nor are they regulated in the country. The regulator has, therefore, warned the public to desist from transacting in digital currency.