Despite jaw-dropping returns, virtual currencies are rife with risk.
Even though blazing-hot industries like artificial intelligence, cloud computing, and legal marijuana have garnered plenty of attention from investors and Wall Street alike, no asset class has been able to hold a candle to cryptocurrencies since the beginning of 2017. After beginning 2017 with a combined market value of $17.7 billion, the aggregate market cap of all digital currencies soared nearly $600 billion to end the year higher by more than 3,300%. It’s very likely the greatest single year for any asset class in history.
Leading that charge has been bitcoin, the world’s largest virtual currency by market cap, and the rise of blockchain technology, blockchain being the digital, distributed, and decentralized ledger that underlies most cryptocurrencies and is responsible for recording and processing transactions without the need for a financial intermediary, like a bank. Blockchain offers numerous currency- and non-currency-related advantages over existing networks, and it’s widely believed to be a game-changer for the financial services industry.
Here’s why avoiding cryptocurrencies might be a smart move
Yet, for as incredible as cryptocurrencies have been, they come with an ever-growing list of risks and concerns. At the end of the day, investing in cryptocurrencies simply may not be worth the headaches they bring to the table. Here are nine reasons investing in cryptocurrencies might be a bad idea.
1. Traditional fundamental metrics are nonexistent
To begin with, cryptocurrencies lack the usual fundamental metrics investors would look for when attempting to assign an appropriate value to an asset. With a stock, investors can pore through balance sheets, income statements, earnings reports, and management commentary, among other data and information, to assess whether a publicly traded company is believed to be heading higher or lower.
However, with cryptocurrencies, there are no fundamental metrics that can be used by investors. With the exceptions of processing speed and daily average transactions, which tell us virtually nothing about the staying power of a digital currency, there are no data points for virtual currency investors to use when analyzing cryptocurrencies.
2. You’re buying the wrong asset
Another issue is that when investors buy digital tokens, they’re really buying into an asset that has no long-term value. The proprietary blockchain technology being developed by these individual cryptocurrencies is where the real value lies. Yet, buying into virtual tokens — even those tethered to a blockchain network — doesn’t give the investor any ownership in the underlying blockchain. Put plainly, the increased adoption of a digital token doesn’t mean anything for the long-term value of a cryptocurrency.
3. Blockchain is years away from being relevant
Though blockchain might be all the buzz at the moment, it’s also suffering from the proof-of-concept conundrum. During numerous small-scale projects and demos, blockchain has performed well. But no big businesses have been willing to take the training wheels off of blockchain, so to speak, to see if it can scale to millions or billions of people. The proof-of-concept conundrum describes this unwillingness to implement blockchain on a broad scale because it’s untested, as well as the need for businesses to implement the technology so it can prove its ability to scale.
It’s quite the Catch-22, and it’s likely to keep blockchain from being a disruptive technology for many years to come.
4. Trading is dominated by emotional investors
Nearly all cryptocurrency investing occurs on decentralized exchanges, which institutional investors traditionally want no part of. With that being said, retail investors have predominantly been the driving force behind virtual currency trading. The danger of turning the reins over to retail investors is that they tend to allow their emotions to get the best of them, relative to Wall Street professionals. This results in cryptocurrencies regularly shooting up and down by double-digit percentages, leading to nauseating volatility.
5. The SEC can’t help you
Next, the Securities and Exchange Commission (SEC) has flat-out warned investors that its hands are tied, and there’s little that it can do should fraud occur. A December 2017 statement from SEC Chairman Jay Clayton notes that decentralized exchanges and trading can often exist and occur outside the confines of the U.S. borders. And, since a number of digital currency transactions are designed to be anonymous, recovering your investment may not be possible.
6. Security can be hit-and-miss
Speaking of fraud, cryptocurrency thefts do occur from time to time, even though blockchain is supposed to be a more secure means of transmitting and storing money. In January, the biggest crypto theft in history (at the time of the theft) was reported by Japanese cryptocurrency exchange Coincheck. All told, cybercriminals absconded with 523 million NEM coins (known as XEM), worth $534 million at the time.
Also, between 2011 and 2014, hackers slowly bled bitcoin from Mt. Gox, which at the time was handling 70% of all bitcoin trading volume. The roughly 850,000 bitcoin that hackers stole would be worth around $7 billion at today’s bitcoin price. If your coins are stolen, there may be little recourse to get them back.
7. Regulation is a double-edged sword
The previous two risks get at the point that tighter regulation is needed. Unfortunately, regulation is a double-edged sword. While tighter regulations would likely reduce instances of fraud, and it may encourage participation from Wall Street, which could improve liquidity and possibly reduce volatility, it would also remove the anonymity that diehard crypto investors have thrived on. As much as regulation is needed, it’s feared within the crypto community, and any changes to that end could lead to wild volatility in virtual token prices.
8. Taxes are a nightmare
One area where regulation has picked up is with regard to cryptocurrency capital gains taxes. To put things plainly, cryptocurrency taxation is an absolute pain in the butt! With the passage of the Tax Cuts and Jobs Act in December, the like-kind exchange loophole that digital currency investors had used to avoid taxation is no more. This means all crypto sales need to be reported as a capital gain or loss — and this includes when you dispose of your digital tokens to purchase goods or services.
Making matters worse, there are no guarantees that decentralized exchanges will provide their members with Form 1099 to accurately denote their cost basis and sales price. This makes it imperative that crypto investors, and even those casually using virtual currencies to buy goods and services, log their cost basis and sales price for tax purposes.
9. There’s little understanding of how this all works
Finally, and perhaps the most glaring reason to avoid cryptocurrencies altogether, most of the American public still has little to no understanding of what digital currencies are all about. A January survey released by cryptocurrency service platform Cobinhood found that only 56% of Americans knew what cryptocurrency is, and four out of five folks had no clue where to buy virtual tokens.
To quote long-term investing great Warren Buffett, “Never invest in a business you cannot understand.”
Read more at: Fool
