What are the risks of investing in cryptocurrency?
The risks of investing in cryptocurrency are considerable – and the rewards on offer are dwindling.
Court cases are dramatic by nature, but a high-profile fraud trial currently playing out in a Manhattan courthouse has become compelling viewing.
It’s also directly relevant to the future of cryptocurrencies, because it centres on a former leader of this fast-growing yet unregulated internet-based industry.
The trial of Sam Bankman-Fried has seen the one-time FTX and FTT kingpin denying fraud charges over a cryptocurrency exchange that collapsed last November.
His trial is scheduled to conclude exactly one year later, yet the outcome is arguably immaterial compared to the reputational damage cryptocurrency has already endured.
That’s because Bankman-Fried was hailed as the poster boy for the entire crypto industry.
This self-declared philanthropist was feted by politicians, adored by the media and hailed as the respectable face of an industry hitherto regarded as shadowy and unaccountable.
Bankman-Fried’s fall from grace underscores the risks of investing in cryptocurrency, which are essential for anyone to understand before taking the plunge…
Rocket from the crypto
We’ve written about cryptocurrencies before, in particular Bitcoin, which introduced the concept of stateless currencies recorded in online transaction ledgers.
The pound in your pocket – to borrow a very old political phrase – is underwritten by the Bank of England.
Its value relative to other goods, services and currencies naturally fluctuates, but its long-term value is only likely to diminish because of inflation.
The same is true of commodities like gold, company shares and Premium Bonds. Their assigned value is tangible, and you can generally resell them at face value.
Currencies backed by a central bank or government are known as fiat, and for a few years, their future seemed threatened by the emergence of digital cryptocurrencies.
These can be created by anyone, assigned any value, and used anywhere in cyberspace without exchange rates or processing fees.
Investors in Bitcoin, Ethereum and other cryptocurrencies dreamed of a future where instant digital transactions would be recorded in an incorruptible ledger known as a blockchain.
Unfortunately, corruption subsequently surfaced everywhere from fraudulent exchanges to worthless coins and hacked digital currency wallets.
In the absence of an underwriting authority guaranteeing the value of a particular crypto, each one is only worth whatever people are willing to pay for it.
Because none of the 23,000 cryptocurrencies in circulation today are secured against tangible assets, they’ve largely become investment vehicles for stock market traders.
A few have become popular, creating a total market capitalisation of around $1 trillion.
However, many have sunk without trace, and most are effectively worthless, especially since few companies accept even the most successful coins – Bitcoin, Ethereum and Tether.
At its peak, one FTT coin was worth almost $85. Today, it’s worth around $1, and many investors have lost their life savings.
The same has happened with non-fungible tokens, or NFTs.
Exchange and mart
The risks of investing in cryptocurrency extend far beyond the actual currencies themselves.
A few weeks ago, police in Hong Kong launched an investigation into a crypto trading exchange which has allegedly lost around £135 million of investor money.
Popular social media influencers were among those arrested after Dubai-based JPEX failed to obtain a licence for virtual asset trading.
This licencing scheme typifies the clumsy attempts by regulators and governments to police an industry trading beyond their borders – and often beyond their reach.
JPEX responded with the familiar crypto exchange tactic of declaring a “liquidity shortage” and immediately preventing investors from withdrawing their funds.
This is common practice, often happening without warning.
So am I safe to invest in crypto?
There are plenty of social media influencers and crypto fans who’d answer that question in the affirmative.
Some will be paid to do so, others have a vested interest in seeing a particular currency gain in value, and a few genuinely believe decentralised finance represents the future.
It’s vital to remember that the risks of investing in cryptocurrency are numerous.
Nobody will compensate you if your investment loses value, your account gets hacked or your chosen coin ceases to exist.
Indeed, the average lifespan of a cryptocurrency is just 15 months.
The Latin phrase ‘caveat emptor’ (buyer beware) has never been so relevant.
