Cryptocurrencies – How safe an investment are they?
Written by Duncan Taylor on July 03, 2018.
At the beginning of 2018 Forbes predicted that the cryptocurrency market, once limited to a few players led by Bitcoin, would soon include over a thousand different cryptocurrencies with a total value estimated at $650bn and counting.
No longer a niche investment, digital assets have entered the mainstream. Last year the CEO of Barclays, Ashok Vaswani, told CNBC that the bank was in discussions with UK regulators regarding cryptocurrencies ‘We have been talking to a couple of fintechs and have actually gone with the fintechs to the Financial Conduct Authority to talk about how we could bring the equivalent of bitcoin, not necessarily bitcoin, but cryptocurrencies into play.’
It has been reported that a third of high net worth individuals around the world already invest in cryptocurrencies or are intending to before the end of the year, a fact which demonstrates that these digital currencies are gaining acceptance as an investment vehicle.
Yet cryptocurrencies remain risky. Are they the future of investment and ‘the next giant leap in the democratisation of venture capital and liquidity where everybody has equal access’, as predicted by Brock Pierce, co-founder of Blockchain Capital, who specialises in venture capital in the ‘crypto ecosystem’ (well, he would say that!), or an overblown novelty whose bubble will burst even more spectacularly than the dot.com bubble of the late 1990s?
As none of us can know for sure, if you are thinking of taking a punt and investing in cryptocurrency I would advise caution. You not only risk losing your money but could be vulnerable to the scams which any new money-making scheme will inevitably attract.
Here are some of the things you need to be wary of:
1. Dodgy exchanges
Cryptocurrency exchanges are where the buying and selling is done, stock markets for digital currencies if you will. There are lots of them and they work in three main ways. Some connect buyers and sellers in exchange for a fee, others offer direct person to person trading with sellers setting their own exchange rate and thirdly, there are brokers similar to foreign exchange dealers. Beware – this is an area where the cowboys have moved in and it is hard to find exchanges that are 100% trustworthy. Back in February 2014, Mt. Gox, who at the time handled over 70% of Bitcoin transactions and were generally thought to be safe, suspended trading overnight when 850,000 Bitcoins were stolen. Most were never recovered. The moral of the story is to do your research before investing in any cryptocurrency and protect purchases by storing them in an offline wallet rather than on an exchange, except when you are actually trading. Even so, in an as-yet unregulated market, trading is never risk-free.
2. Initial Coin Offerings (ICOs)
These are the cryptocurrency equivalent of the stock market’s initial public offering, created by start ups to raise large sums of money. There is a very real danger that the initial value is hugely overestimated or that an ICO is launched before the technology to support a cryptocurrency is ready. The US Securities and Exchange Commission (SEC) monitors them and will step in to suspend trading if it suspects foul play such as market manipulation and insider trading.
Lessons were learnt in 2016 when DAO, a digital decentralised autonomous organisation, successfully raised $150 million in the largest crowdfunding campaign, a third of which was immediately hacked overnight. Those affected were investors in a cryptocurrency called Ether and the incident led to Ethereum splitting into two different forks. Both China and South Korea have banned ICOs.
3. Pyramid and Ponzi schemes
The SEC describes a Ponzi scheme as ‘an investment fraud that involves the payment of purported returns to existing investors from funds contributed by new investors.’ As few people have a firm grasp on the blockchain technology which is behind all cryptocurrencies they can be easily duped with false promises and jargon which they don’t understand. Media hyped reports about get-rich-quick schemes also fuel demand from naïve investors. The upshot is that a lot of people have lost a lot of money. The highest profile Ponzi scheme to date is OneCoin, now banned from trading in a number of countries, including the US.
4. Pump and dump
Just as the price of stocks can be artificially inflated through false and misleading positive statements so that shares bought cheaply can be sold subsequently at a higher price, so cryptocurrencies are vulnerable to speculatory shady tactics. While Bitcoin is big enough to make price manipulation difficult, smaller cryptocurrencies are ripe for pumping and dumping with online groups dedicated to this tactic. As ever, you would be wise to take note of the maxim ‘if it seems too good to be true, it probably is.’
5. Fake cryptocurrencies
Last year Action Fraud and City of London Police exposed a cold calling scammer after nine victims reported losses in excess of £150,000 on the purchase of an entirely fictitious digital currency. One golden rule: never ever purchase cryptocurrencies from a cold caller. Avoid social media links too – impersonators purporting to be well-known cryptocurrency accounts are rife on Twitter and Facebook. They direct unsuspecting followers to bogus web addresses where they are duped into paying for fake digital currency.
While cryptocurrencies are not bad per se, the high stakes and potential returns as well as the anonymity this kind of trading offers are a magnet for unscrupulous operators looking to make a buck. Not only that but they have yet to prove their worth as long term investments which generate a return. That’s why, for now, I will be keeping my money in more traditional investments which have a proven track record and can be regulated.