Cryptocurrencies continue to surge in popularity. Although the opportunities seem compelling, any investment should be in full knowledge of the potential risks too. This guide will help you get a handle on both sides of the coin.
The number of UK cryptocurrency investors recently hit 2.6 million – a surge of 1.1 million in just a year – according to new figures from the financial regulator. They are booming all around the world and we increasingly hear from users wondering whether they should join in. Our response, as ever, is that you must understand both the risks and the opportunities any investment represents. And with this particular one, there is a lot to be said on both sides. Our quick guide will help you get a handle on this fast-developing sector.
What are cryptocurrencies?
In essence, cryptocurrencies are digital representations of value – electronic money – that are based on various forms of Distributed Ledger Technology. These are secure digital networks for recording the transaction of assets (and contract rights) in multiple places, peer-to-peer and with no centralised data store.
In essence, cryptocurrencies are digital representations of value – electronic money – that are based on various forms of Distributed Ledger Technology.
The underlying technology for all of this is blockchain. To secure the network and process the transactions, blocks of transactions must be chained together – hence the name – and this is carried out by solving immensely complex computational problems. Doing this produces the currency as a reward, and so digital money can be thought of as a tokenised representation of (computational) effort, and luck. The chances of producing a coin are infinitesimal and so it is aptly named “mining”, as for gold.
The sector has since swollen to somewhere between 4,300 to 5,500 cryptocurrencies globally, depending on estimates, with a total market cap of around £220 billion
Bitcoin, the first and still most important cryptocurrency, came into being in 2008. The sector has since swollen to somewhere between 4,300 to 5,500 cryptocurrencies globally, depending on estimates, with a total market cap of around £220 billion. Ethereum, Ripple and Litecoin are just a few other names you might hear.
Why are cryptocurrencies so popular?
The underlying blockchain technology on which cryptocurrencies are based is arguably the most exciting thing about this area. Because any changes to a block of transactions requires changes to preceding blocks and leaves a trail visible for all to see (through the Distributed Ledger), a chain is pretty much impossible to hack. The technology is therefore hailed as the future for payment systems and more.
This, and the sheer difficulty of mining new “coins” or tokens, make digital currencies highly secure. The fact that there is no centralised register also makes holding them anonymous via a digital “wallet”.
More importantly, there is a mathematical limit on the number of coins that can be generated (in Bitcoin’s case, 21 million). This is in sharp contrast to “fiat” currencies, which governments increasingly “print” more of at worrying speed. Advocates therefore see cryptocurrencies as stabler stores of value which cannot have their worth eroded away by inflation.
Advocates therefore see cryptocurrencies as stabler stores of value which cannot have their worth eroded away by inflation
Added to these points is clearly all the media hype – and advertising – around cryptocurrencies. Few will have missed the stunning rise in value of Bitcoin in recent years and it has performed particularly well through the maelstrom of the COVID-19 pandemic.
The figures being circulated are, in fact, mind-boggling. Bitcoin surged to $11,000 at the end of July; Crypto Research Report predicts it will hit $20,000 this year and keep rising to almost $400,000 by 2030.
Cryptocurrencies have been coming up increasingly in our conversations with investors. Exciting though they are, this is one area where it’s especially important to take advice before investing any significant amounts. Why not arrange a free consultation with an expert to see how your current investments look, and where cryptocurrencies might fit?
What are the potential risks of cryptocurrencies?
There is no denying how compelling those kinds of projections are (and the predictions for several other leading cryptocurrencies are close to vertical too). However, there are some very serious risks to be aware of that should temper any investor’s enthusiasm.
The risks of cryptocurrencies are actually embedded in their perceived benefits to a large extent: while they are largely beyond government control at present, they are also beyond government protection
The risks of cryptocurrencies are actually embedded in their perceived benefits to a large extent: while they are largely beyond government control at present, they are also beyond government protection.
Although regulatory protection is developing, currently there is little to guard against fraud and theft in this arena. Digital wallets are vulnerable to theft (via the devices they are stored on) and, while the blockchain itself may be impenetrable, there have been cases of exchanges being hacked and hundreds of millions of pounds worth of cryptocurrency stolen. This issue is compounded by where these assets are purchased. According to the FCA, 83% of British purchasers of cryptocurrencies are using non-UK exchanges.
There is also a risk that governments will come to see cryptocurrencies as risks to their own currencies and oversight since their anonymity makes them ideal for criminal doings
There is also a risk that governments will come to see cryptocurrencies as risks to their own currencies and oversight since their anonymity makes them ideal for criminal doings. It is not unfeasible that one government, several or all could legislate against one, or all, of the cryptocurrencies at some point in the future, and there have already been rumblings from a few governments to this effect.
Weighing up whether to invest
All of these issues mean that cryptocurrencies can be incredibly volatile. A sudden government ruling or security breach could cause a sell-off that causes value to be wiped out at a stroke. On the other hand, a positive development like government recognition or the launch of a new technology which brings cryptocurrencies to the masses, could make millionaires overnight.
When weighing up whether (and how much) to invest in cryptocurrencies, it pays to remember that “crypto” means “secret” or “hidden”. This is undoubtedly an exciting area, but it is also very arcane, and holds out risks equal to – if not very much greater than – its opportunities.
Cryptocurrencies among the most “alternative” of alternative asset classes, and as such we would argue that you should never sink a hefty proportion of your wealth into them. They may have a place in your portfolio, but the size of that will depend on your risk-profile, objectives and time-horizon, as well as the existing asset allocation of your wealth. When to invest and how are also key questions to answer before diving in.
When weighing up whether (and how much) to invest in cryptocurrencies, it pays to remember that “crypto” means “secret” or “hidden”
The leading wealth managers on our panel can offer expertise in this and the whole universe of assets, and in relation to the whole of what you want to achieve financially, rather than as an isolated bet. You can certainly join the masses who are diving into cryptocurrencies, but do so wisely. Use our free matching service to talk to an expert first.