At a glance...
Many things that are good about cryptocurrency can quickly turn bad if you dive in without knowing the risks. Investing in cryptocurrency offers you a new way to let your money grow that is independent of traditional governmental controls. Still, it comes with its own set of limitations.
Good #1: Potential for High Returns
From 2016 to 2020, the S&P 500 index of large cap US equities compounded at a growth rate of 14.5% per annum. Over the same period, the price (in US dollars) of bitcoin, the oldest and most popular cryptocurrency, shot up at a compounded growth rate of 131.5% per annum.
Bad #1: Potential for Large Losses
However, it’s not always a one-way street. Unlike traditional currencies, the value of a cryptocurrency can be highly volatile, swinging between extreme peaks and lows within relatively short spans of time. The monthly percentage change in the price of bitcoin in USD recorded an annualised volatility of approximately 90% over the period of 2016-2020. By contrast, the same statistic was just 15.3% for S&P 500. Monthly bitcoin returns fluctuated between 76.1% and -37.6% during the 5-year period. Getting the timing right on a cryptocurrency investment is absolutely crucial.
Good #2: It Can Bail You Out
The value of cryptocurrency is subject to the ebbs and flows of its demand and supply. Thus, trends on the value of cryptocurrency can be quite independent of other traditional investments, such as gold. Investing in cryptocurrency, among other things, can sometimes help to keep your portfolio afloat when other investments take a turn for the worse. This reduces the risk of relying too heavily on any one investment.
Bad #2: It Can Bail on You
That’s not to say that cryptocurrency is a fail-safe lifeline; sometimes, it will flop when you need it most. For example, the S&P 500 declined in 17 of the 60 months from 2016-2020. Out of those 17 months, the price of bitcoin rose in 7 of them but fell in the remaining 10. Bitcoin actually fell in 4 of the 5 worst months for the S&P 500. The lesson here is that cryptocurrency isn’t a panacea; some days will still be red days.
Good #3: Limited Edition
For bitcoin at least, there’s a hard cap of the supply of coins that can exist in circulation – 21 million. As of March 2021, about 18.6 million coins have been created or “mined”, so there are less than 3 million left. In future, when all bitcoins have been tapped out, it’s not hard to imagine that the price will only be set to rise. Related to this, however, one of bitcoin’s features is that the rate at which coins are mined slows over time, through a process called “halving”. If you haven’t gotten your hands on bitcoin by now, you might still have some time yet.
Bad #3: …But Not as Limited as You Thought
While bitcoin might eventually be in limited supply, there are still myriads of other cryptocurrencies. New ones are probably being created as we speak. Also, although many cryptocurrencies follow bitcoin’s model, not all have absolute limits. For example, the second-largest cryptocurrency, ether, is designed to have an unlimited overall supply but a maximum annual supply of 18 million coins.
Good #4: Free from Government Control
Traditional currencies can be subject to rising inflation, depending on the policy choices of central banks. Since cryptocurrency operates on a completely decentralised and independent market mechanism, it isn’t affected by direct controls like monetary policy. Therefore, it can offer an attractive alternative to watching your money crumble in the bank as inflation sets in over time.
Bad #4: Unregulated and Unbacked
Of course, there’s a downside to not being tied to any central authority. Without the support of a government organisation, no one is obligated to help you get your money back should you lose it. This makes crypto trading platforms particularly prime poaching grounds for scammers targeting unsuspecting investors. A study in 2019 revealed that 25% of bitcoin users are involved in some form of illegal activity and that a staggering 46% of transactions are associated with illegal activity.
Good #5: Growing Acceptance
The number of merchant transactions completed in bitcoin over time has been exponentially rising over the last few years. PayPal has enabled its US users to buy, sell, hold and checkout with cryptocurrencies. With the growing support for cryptocurrencies, it’s also no surprise that the number of bitcoin digital wallets has also been on a huge rise. More and more institutional investors are also beginning to explore cryptocurrency investments. If this trend continues, cryptocurrency could become a mainstream payment method sometime in the not-too-distant future.
Bad #5: …But Still No Mass Adoption
At present, however, not many other places accept cryptocurrency as a payment method. Most times, you’d have to convert your cryptocurrency back into your country’s currency to make a purchase, but this is another source of uncertainty. Cryptocurrency’s high volatility means that its value in your local currency could swing wildly even within a day, making it a rather unpredictable choice of currency for buying physical goods and services.
|Potential High Returns
|Potential for Large Losses
|It Can Bail You Out
|It Can Bail on You
|Not as Limited as You Thought
|Free from Government Control
|Unregulated and Unbacked
|Still No Mass Adoption
This list isn’t exhaustive. Still, what this shows us is that cryptocurrency’s potential benefits are tempered by its large risks. Most people would advise that cryptocurrency be one component of several in a healthy investment portfolio, to reap its benefits and offset its risks with other investments. Eventually, however, it’s up to you to make the best decision for yourself after studying the pros and cons.