– With digital currency proving to be the newest fad, it is time to analyse practicality of the changed scenario
With digital currency proving to be the newest fad in the financial world, it is time to analyse the practicality of the changed scenario and its feasability going forward
Over the last year, there has been a frenzy around the prospect of investing into cryptocurrencies and digital investments. People have been mortgaging their homes to buy Bitcoins- a series of ones and zeroes, which clearly have no physical presence. The year 2017 saw the Bitcoin soar from $1000 to $19000 at the close of the year. It is not just Bitcoins but also other digital currencies and digital assets that have been the focal point of discussions globally.
On the one hand, while an increasing number of online retailers are accepting digital currencies, many governments have maintained differing positions on the subject. While governments such as Saudi Arabia adopt a laissez faire approach to Bitcoins, other countries such as South Korea and China are banning the cryptocurrency, terming it an illegal tender. In the light of current cryptocurrency situation, it is worthwhile to pause and ponder on the mechanics of investing into these instruments exploring if it does really make for a wise investment.
Digital currencies or virtual currencies, are unregulated and often secured by cryptography and taking the form of store of value and used as a means of paying for goods and services. Some of the commonly known virtual currencies, Bitcoin, Ether and Ripple are issued and controlled by their developers. Contrary to common belief, not all virtual currencies are cryptocurrencies since not all use cryptography.
Digital currency users work on a peer to peer network to execute direct transactions; each transaction typically documented in a blockchain for that virtual currency. The blockchain operates as a database of all transactions entered in by all users. The use of virtual currencies does not require user identity authentication, and hence all transactions entered in a blockchain are anonymous.
There is immense ease of transacting in these currencies, as these are freely tradeable online or over virtual currency exchanges, and dedicated self-service kiosks in exchange of regulated currencies such as the dollar or in of another virtual currency, let’s say - bitcoins in Exchange for Ether.
So, are investments in virtual currencies the bus you’d want to ride on, keeping in mind the noise around them? To start with, it would be good to explore the benefits of investing into digital assets.
Digital currencies are appreciating at a stupendous rate. The Bitcoin has returned 35,971.51% gains on an investment made in 2013 and Ethereum rallied 8,500% in 2017. The combined market cap of the total cryptocurrency market appreciated 2,800% last year.
Since digital assets are not correlated with other assets, any movement in the prices of other currencies and assets have no impact on them. This is especially significant during global events such as the Brexit, EU crisis and so on, when fiat currencies came under pressure. However, the cryptocurrency landscape has only been on a run-up during these phases.
Store of value
Bitcoins and other crypto assets are fixed in supply and cannot be increased in quantity. This ensures that the value doesn’t depreciate.
Ease of transaction
Since cryptocurrencies are not correlated or linked to any currency, exchange rates do not affect the value of transactions, enabling them to be seamless and easy.
Foundation for other investments
The upcoming trend in the cryptocurrency space is the funding of startups. Also, blockchain technology helps in investments into other assets and investment schemes. But is the picture as rosy as it looks? To get complete clarity, it worthwhile to understand the potential downsides of investing into virtual currencies.
Since the users of cryptocurrency do not have a physical presence, there is a huge risk of fraud since their authenticity cannot be ascertained. Also, since the jurisdictions in which the users operate may be different, it becomes increasingly difficult to recover the invested monies.
Since users of digital currency are anonymous, their track record cannot be established and hence, the credibility is in question.
Liquidity of digital currency is always uncertain, since the number active buyers and sellers in the marketplace may not be enough. In case of no secondary market for a digital currency, illiquidity is a major issue.
Volatility and lack of transparency
These investments are extremely volatile. Last year, the value of Bitcoin went from $1000 to about $19,000 before dropping to $13,000 at the end of the year. These are highly speculative investments and extremely opaque due to non- availability of publicly available information.
Digital currencies are highly prone to security risks as these are not always encrypted or the users may not have taken suitable security measures. Tokyo-based cryptocurrency exchange Coincheck was hacked in what is believed to be the largest exchange theft that wiped off as much as approximately $530 million in value.
Frauds and scams also are a huge risk in cases of the use of the currency to make purchases.
Money Laundering and Terrorist Financing
Since the identity of the users is not established in case of digital assets, the funds invested are prone to misuse and funding of illegal activities. Even though as an investor, one might buy the currency for pure investment purpose, they can always come under the lens of enforcement agencies if the funds are used for any illicit purpose. The transactions in case of virtual currencies are anonymous, exacerbating the problem. As a Family Office Advisor, I would recommend that investors need to access their choice of investment for certain key qualities. The main parameters I would be looking for include: a) Clean b) Patient c) Quiet d) Simple To Manage e) Well Planned and; f) Must contribute to leaving behind a better world
While digital investments do provide stellar returns, they do not possess any of the aforementioned characteristics of a wise investment option.
As Warren Buffett, the guru of investing says about cryptocurrency: “Stay away from it. It’s a mirage, basically”.
Peter Smith, Chief Executive Officer, Blockchain Ltd