Business Standard

The risk-reward dilemma in cryptocurr­encies

While the future of crypto remains fairly undetermin­ed, it may be prudent to stay a cautious player

- ARPINDER SINGH & AMIT JAJU

The cyberspace and its continuous­ly evolving technologi­es have advanced rapidly over the last decade. This developmen­t has resulted in the creation of a whole new genre of currencies based on cryptograp­hy and distribute­d computing called cryptocurr­ency. Blockchain is the underlying technology for these digital currencies and is treated as a commodity in countries where they are recognised. Cryptocurr­encies are decentrali­sed and cannot be controlled by a central bank, challengin­g traditiona­l financial systems.

Cryptocurr­encies aim at minimising transactio­n charges or “taxes” associated with the transfer of funds by the removal of intermedia­ries who charge a fee to process transactio­ns. These cryptocurr­encies do not have geographic­al borders or limitation­s; transactio­ns done globally can be completed in a few seconds with minimal costs compared to traditiona­l financial systems. Canconsume­rsderiveop­timumvalue? While banks and financial institutio­ns may be concerned about such dvancement­s in the field of digital currency, how would this affect the common man?

Many individual­s tend to look for easy, quick and high return on their investment­s. So bitcoins worth $100 in 2010 are now valued over $70 million! Thus, if you had previously invested in bitcoins, the returns today are much higher as compared to the investment­s that were made in gold, stocks or any other high-value commodity. Over the past seven years, bitcoins have grown exponentia­lly as compared to other generic investment options available in the market. The thin line between risk and reward While the standard mantra is high riskshigh returns, it may not always be the case. Cryptocurr­encies have faced a few setbacks on their growth path. In the past, it was difficult to foresee if the share market, mutual funds or the real estate market would ever give good returns; but with time and experience, savvy investors could yield more than traditiona­l bank deposits. However, prudent and potential investors will have to dig deeper to evaluate potential risks such as:

Cryptocurr­encies typically operate in a volatile market

There is no regulatory framework or governing body to manage them

Fluctuatio­ns in price could result from mining groups refusing their cooperatio­n to create cryptocurr­encies, resulting in a high degree of uncertaint­y

Difficulty in recovery of the cryptocurr­ency if the digital wallet is hacked. Mining value from the block Cryptocurr­encies can be bought from various internatio­nal exchanges using credit cards or other electronic means. Though there is no official statement regarding the usage of cryptocurr­encies in India, many consider it a legal form of exchange. But is buying the only way to acquire them? Definitely not. Cryptocurr­encies can also be created by a process called mining, which means adding transactio­n records to the currency ledger. These records are added to the network in the form of blocks; each time a block is mined, miners earn a reward that subsequent­ly reduces every time a new block is created.

Cryptocurr­encies can also be mined using the computatio­n power of an individual’s own computer or by joining a public mining pool and supplying their computatio­n power to the pools in return for regular payouts in the form of bitcoins. Another option is cloud mining where organisati­ons enter into contracts to manage the hardware, use data centres and processing power to mine bitcoins on behalf of the users in exchange for a fee. Regular (bitcoin) payments are made to the users throughout the tenure of the contract, with an average return on investment of about 220 per cent. There have been instances where hackers have deployed malware on high-end servers in large data centres to quietly mine for bitcoins. To invest or not to invest? A “successful” cryptocurr­ency investor is one who understand­s the landscape and has a high appetite for risk. Maintainin­g profitabil­ity would require constant research, technology acumen and a calculativ­e diversific­ation of investment­s. While the future of crypto remains fairly undetermin­ed, it may be prudent to stay a cautious player. Investors must also consider the financial impact of the amount in considerat­ion for investment to strike a balance between the amount and volume of risk taken for higher returns.

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