Managing the Risks of Cryptocurrency & Blockchain Investing
Anyone who has paid attention to cryptocurrencies like Bitcoin over the last couple of years understands just how volatile the market can be. In March 2017, one Bitcoin was worth around $1,000; by December it was trading hands at more than $19,000. It’s been a different story in 2018: over the first three months of the year, the price of Bitcoin (which is currently valued at around $8,500) has fluctuated so much it’s been giving investors whiplash. Investors need to understand that there are serious risks when investing in cryptocurrencies; they also need to determine whether the risks outweigh the potential returns.
There are a number of reasons why cryptocurrency prices have been so volatile. First, the industry is still in its infancy and is trying to find its legs. There are also hundreds of different cryptocurrencies out there jostling for investor attention.
Thirdly, blockchain, the underlying technology of all cryptocurrency, is not easy to understand or explain; this can make it difficult for investors to find an entry and exit point and what moves cryptocurrency prices.
Case in point, cryptocurrency is used like a traditional fiat currency to buy products and services. Investors also consider cryptocurrency to be a commodity, like gold and silver. All of these factors make cryptocurrencies vulnerable to market fluctuations—just like any other commodity or stock would be.
Then there’s the fear that cryptocurrencies are susceptible to fraud and hackers. Keep in mind, Bitcoin was invented in 2008, and since then, blockchain has operated without any serious disruption. Any problems associated with cryptocurrencies like Bitcoin are due to human error and mismanagement, not flaws in the underlying technology.
In fact, many believe that blockchain is the new Internet and will revolutionize the way businesses operate.
Up until now, when people think of blockchain, they think of cryptocurrency. But blockchain can be broken down into three different sections: cryptocurrency (Bitcoin, Ripple), platform (Ethereum, IOTA), and tokens (TRON, EOS).
In the not too distant future, blockchain is expected to be the primary building block for the new internet. The company with the best platform could revolutionize the Internet and be the biggest winner.
All of this is to say, cryptocurrencies will, like every investment, remain volatile, but because it’s built on blockchain technology, it isn’t going away. If anything, it is becoming more and more popular; businesses and banks are developing their own proprietary blockchain technology.
Moreover, the head of the Bank of England and chairman of the Financial Stability Board (FSB) said at the recently held G20 Summit, “that crypto-assets do not pose risks to global financial stability at this time.”1
This has buoyed cryptocurrency prices as Carney’s comments suggest regulations for cryptocurrencies are not in the cards right now. For the record, the FSB is the financial watchdog that governs regulations for the G20 economies.
If Carney wanted, he could pull the plug on cryptocurrencies and implement crippling crypto regulations. But he didn’t. That’s why it’s important for investors to have a longer investing horizon when it comes to cryptocurrencies.
For example, during the heady days of the dotcom era, investors were buying every flashing IPO because they didn’t want to get left behind or miss out. Astute investors diversified their portfolio with tech stocks. If they purchased Amazon and Pets.com, they lost out on one but did well with the other.
Cryptocurrencies have the same kind of inherent risks. The returns on the better cryptocurrencies or blockchain companies should offset the losses of the other ones. A diversified investing portfolio then should contain some cryptocurrencies and blockchain companies.
The big questions are, what percentage and which companies do you choose?
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- “G20 watchdog focuses on rules review, holds fire on cryptocurrencies,” Reuters, March 18, 2018; https://www.reuters.com/article/us-g20-regulations-carney/g20-watchdog-focuses-on-rules-review-holds-fire-on-cryptocurrencies-idUSKBN1GU0SF.
Photo Credit: iStock.com/Marc Bruxelle