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The Risks and Rewards of Investing in Cryptocurrencies

Cryptocurrencies such as Bitcoin and Ethereum are now available to buy and sell, and they’re driving the creation of diverse products and services that cater to them. Let’s examine whether these types of digital money are an asset, an investment, or a currency – and whether they’re worth your real-world cash.

All about alternative assets

Traditionally, there were three types of investments: stocks (equities), bonds (fixed income generators), and cash and cash equivalents. Later, investors moved into alternative asset classes: timber, works of art, bottles of fine wine, real estate, hedge funds, private equities, and commodities. Now, many investors have begun to wonder how cryptocurrencies fit into an investment portfolio.

The two main types of alternative asset classes are collectibles and high finance. Collectibles are expected to improve in value over time. Examples include real estate, works of art, comic books, and bottles of fine wine. Since no one can accurately assess collectibles’ value until they’re sold, they are often considered illiquid.

The second type of alternative asset class, high finance, is often limited to sophisticated investors, high-net-worth individuals, and institutional investors. Examples of such assets include hedge funds, private equities, and commodities. However, retail investors have been able to invest in them, too, thanks to the creation of mutual funds, exchange-traded funds, commodity futures, and shares in mining companies.

In Hong Kong, cryptocurrencies are categorized as a virtual commodity. That classification places them in the high-finance category. Indeed, they have several characteristics in common with other investments in this class, none of which follow the rules and standards applied to traditional investments like stocks and bonds. In practice, they work like both an investment and an asset.

How cryptocurrencies fit into high finance

Non-Normal, Non-Linear Returns

Cryptocurrency values are not correlated to any specific market activity or events. They don’t move in tandem with markets in any country, nor any of the industries that have developed around them. Also, their increases and declines are unpredictable, ranging from insignificant to meteoric. Investors cannot be certain of a positive return on their investment, or even of recapturing the initial cost of the investment.

An illiquid asset

Cryptocurrency is tough to convert into ready cash or other real-world goods. It has no physical form, limited instead to 0s and 1s on a computer.

Unpredictable value

Its value is difficult to assess and largely based on the demand for it, which can suddenly spike or plunge for hard-to-understand reasons. Cryptocurrency owners can never be certain of the value of their investment until they sell it, making it volatile and highly speculative.

Unreliable benchmarks

There’s no way to reasonably speculate about a cryptocurrency’s performance in the near and distant future, so it has no reliable benchmarks – nor any benchmarks at all.

Not available to everyone

There is a limited amount of each cryptocurrency available for purchase. Thus, not everyone can own a specific kind of cryptocurrency. Hence, the very characteristic that makes it attractive to investors also makes it an alternative asset.

Limiting its quantities protects cryptocurrencies from decreasing in value via market oversaturation. A government can always print more cash, decreasing its currency’s existing value. But there’s a fixed amount of each cryptocurrency that is or ever will be available, so it’s not vulnerable to inflation or dilution.

However, this also means cryptocurrency cannot be owned and used by everyone. Most of it is owned or controlled by a relatively small number of people, who exercise a great deal of control over how much of it is traded and how often. By default, that limits access to it.

Do your research before you invest

Investors have over 500 different types of cryptocurrency to choose from. The virtual commodity’s value, use, and fungibility will vary over time and among the different types of cryptocurrency.

Companies, industries, and governments are working to create their own brand of virtual currency. Market actors have begun to unveil traditional investment instruments based on cryptocurrencies. And traditional banks and some private companies are working to back the value of select cryptocurrencies with real-world assets.

Wrap-Up

Carefully research any cryptocurrency you intend to purchase. Track its performance, development, and any problems related to it. While there are often no signs that a cryptocurrency’s value will drop sharply or soar to new heights, investors with a high-risk tolerance can at least try to avoid purchasing or selling their cryptocurrency at record highs or lows, respectively.

Whether cryptocurrencies remain a highly speculative investment or go mainstream, you may be able to benefit from the increase in the value of those that survive and thrive in the market. Just remember that the risks for these investments can be as astronomical as their potential returns – investing in them is far closer to gambling than traditional investing. Limit the amount of your portfolio you devote to cryptocurrencies. There are far safer, and consequently far slower, ways to build your wealth.

In short, if you decide to invest in cryptocurrency, only invest as much money as you are willing to lose.

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