The oracle of Omaha, Warren Buffett, once famously said, “You try to be greedy when others are fearful. And you try to be fearful when others are greedy.” This according to him is one of the recipes to success. Investors may need to take a leaf out of Buffett's handbook as they look to jump on to the bitcoin bandwagon. Cryptocurrencies as a whole have put financial markets in a frenzy over the past few weeks as reports of unreal gains made rounds.
The obsession or lure with cryptocurrencies is understandable—it has become the shortcut to making quick money. Cryptocurrencies such as Bitcoin, Ethereum, Bitcoin Cash, Ripple and Litecoin, among many others, have given investors massive gains over the past two years. Bitcoin was trading at $960.79 in January (already considered to have hit a high), but it soon broke all reasoning when it surged to a whopping $18,000 on December 8. Similarly, Ethereum, Ripple and Litecoin too have given daring investors, some quick bucks.
But as Ralph Waldo Emerson puts it, “Money often costs too much.” Yes, cryptocurrencies do seem to have tremendous potential. But can it really replace or even co-exist with existing currencies? Cryptocurrency is digital currency and is mostly decentralised and unregulated, which means, there is no government control. It works like fiat currency, which is declared as legal tender but is not backed by any physical commodity such as gold. Thus, the value is determined by demand and supply. Cryptocurrencies, like fiat money is not linked to physical reserves and risks becoming worthless due to hyperinflation.
Similarly, using these digital currencies to purchase goods and services, can be problematic. It can't be withdrawn from an ATM or any of the traditional routes which are used to transact physical currency. Even Bitcoin, the most well known cryptocoin is almost exclusive to just a handful of e-commerce websites. All your bitcoin riches are worthless unless you can exchange it with fiat money. This is another grey area as far as cryptocurrencies are concerned. Unlike stock trades, it isn't easy to sell cryptocurrencies. There have been many reports of investors unable to execute sell orders and only receiving the trade value after months. While it is fraught with risks, the massive surge in first-time investors into the crypto-world is alarming. The current market capitalisation of Bitcoin is well over $278 billion.
Cryptocurrency, just like any other digital-based product is vulnerable to hacks. In 2016, over $50 million in ether was stolen from a fund known as DAO. The lack of accountability and regulation also makes it extremely volatile. The DAO hack resulted in a violent market correction, causing the Ethereum (cryptocurrency) to tumble. If following the pulse of traditional investors wasn't daunting enough, cryptocurrency investors face a Goliath of a task speculating the mindset of the digital currency community.
Grievance redressal is another issue that will grapple investors. Unlike other investment avenues such as stocks and bonds, there is no authority like SEBI, that you can approach in case of any inconvenience. If you get duped while trading in bitcoin, it is almost impossible to trace the money, and having no authority to go to for help serves as a double-whammy. There is no clear distinction as far as legality is concerned. Although it hasn't been termed illegal, no authority in India has recognised cryptocurrencies as a 'currency'. The RBI issued statements warning users of the risks involved in dealing cryptocurrencies and has also added that it is yet to issue licenses to companies trading in any digital currency. The massive interest in Bitcoin and other cryptocurrencies also means payday for Ponzi schemes, which feed on the lack of clarity in digital currency. Numerous investors have been lured by such schemes to invest in cryptocoins but have been unable to cash out. They are instead, asked to buy other cryptocurrencies.
The bottomline is, investors need to maintain extreme caution while dealing with cryptocurrencies. As Peter Lynch puts it, “Know what you own, and know why you own it.” Not all investments grant huge and quick paydays. Treading with caution can help in creating longterm gains, but investors need to be patient. You might as well go to a casino or a club, if you are looking for some quick excitement. Crypto investing, like any other investment option, requires specialised knowledge. It is therefore advisable for the uninitiated to understand the risks involved before diving in.
