Cryptocurrency: Digital gold or fool's gold?

The excitement is palpable. Bitcoin's significant price rise after the launch of a Bitcoin ETF (exchange-traded fund) in the US and heightened interest from the heavyweight investment firm Blackrock has created a general atmosphere of FOMO (fear of missing out) among investors eager to partake in what many see as the digital currency gold rush.

However, this euphoria masks underlying concerns. The promise of quick gains should not overshadow the inherent risks and volatility associated with these digital assets. This article delves into the reasons why exercising caution or avoiding cryptocurrencies altogether may be wise.

A house of cards

Cryptocurrencies are speculative investments by nature. They lack the tangible assets or cash flow that typically underpin traditional financial assets. Therefore, buyers can only hope their price will rise since there is no underlying asset. Essentially, one is not buying the actual asset but betting on how well it will do.

Their value is largely driven by market speculation and perceived scarcity. The aspect of scarcity is particularly highlighted by Bitcoin's protocol, which includes a "halving" mechanism intended to limit supply and increase scarcity. While scarcity might drive prices up initially due to increased demand, it also contributes to volatility and extreme price fluctuations.

The volatile storms of crypto seas

The cryptocurrency market is notorious for its volatility. Bitcoin, for instance, has seen over 300 instances of losing more than 10 per cent of its value in a single day over the past decade.

The smaller and lesser-known cryptocurrencies are even more unstable, with some losing a significant portion of their value overnight. This extreme volatility underlines the speculative nature of these assets and poses a substantial risk to investors.

Legal and regulatory uncertainties

Cryptocurrencies lack clear regulation and government backing. While some countries like El Salvador and the Central African Republic have adopted Bitcoin as an official currency to combat inflation (they have largely failed so far), cryptocurrencies' legal and regulatory status remains largely uncertain worldwide.

While cryptocurrencies are not banned in India, the government introduced a stringent tax system on their transactions in an apparent attempt to discourage investment. A hefty 30 per cent tax is levied on income from cryptocurrency trading, with a 1 per cent tax deducted at source (TDS).

Rampant frauds and security concerns

Due to a lack of regulation, the cryptocurrency industry is riddled with fraud, scams and security vulnerabilities. The collapse of the FTX exchange and the alleged fraudulent activities of its founder, Sam Bankman-Fried, brought these issues to the forefront. During the FTX debacle, several major wallets suspended withdrawals, causing panic among investors and raising questions about the security and reliability of these platforms.

Crypto scams and hacks have also plagued the industry, resulting in billions of dollars in investor losses. The industry's lack of regulation and the technical challenges of tracing fraudulent activities due to blockchain technology leave victims with limited recourse.

Celebrity influence

Celebrity and organisational influence on cryptocurrency prices is undeniable. For example, Elon Musk's shifting opinions on Bitcoin have notably impacted its market value. Social media celebrity endorsements can lead to pump-and-dump schemes, temporarily inflating prices before they crash. Even sceptics like BlackRock CEO Larry Fink have changed their tune, as demonstrated by BlackRock's recent cryptocurrency ETF launch. These instances underscore the cryptocurrency market's sensitivity to external influences.

Our word

Unlike stocks which are backed by companies generating revenue, cryptocurrencies are purely speculative instruments with no inherent worth beyond what the next buyer is willing to pay. Extreme price swings can wipe out a significant portion of crypto investments in a matter of hours or days.

Investors are advised to exercise extreme caution considering the risks, including pump-and-dump schemes, scams, and high levels of speculation. It's recommended to avoid investing in cryptocurrencies or, at the very least, to only invest what you can afford to lose.

Also read: Bitcoin's mirage of legitimacy gets entrenched