What are the risks of investing in cryptocurrency

Many Aussies are jumping on the cryptocurrency bandwagon but a financial adviser has warned that it’s not for everyone.

In the last 10 years, the total value of all cryptocurrency has increased over 133,000 per cent from less than $US1.5 billion ($A2 billion) to over $US2.4 trillion ($A3.2 trillion) today. Beyond even these highs, crypto like bitcoin is tipped to continue to rise strongly over the next 12 months.

Along with this increase in value and the future potential gains, there has been a lot of press attention, leading many Aussies to question whether crypto should be part of their investment portfolio.

But because of the complexity surrounding crypto, the challenges around buying and selling, and concerns about the security of crypto platforms, many of these same would-be crypto investors are struggling to understand whether they should join the crypto movement.

What’s driving the popularity of cryptocurrency?

The basis of the majority of crypto like bitcoin and other digital assets is blockchain, which is technology that has been around since 1991. But it wasn’t until 2009 that bitcoin was invented, and since then it has grown and grown in popularity.

The ups and downs of crypto have been huge since inception but when you look over the long term, the upward trajectory is clear. In recent years in particular, we’ve seen the adoption by a bunch of big groups as a form of payment – including Tesla, PayPal and even the entire country of El Salvador.

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A banner with the logo of bitcoin during the cryptocurrency conference Bitcoin 2021. Picture: AFP.

This ‘validation’ of crypto by these big players is shifting public opinion and we’re now seeing people of all ages investing in greater numbers than ever before.

Another driving factor of the growth of crypto has been the fact property and share markets have been hot in Australia and around the world off the back of covid, coupled with interest rates being at all time lows.

Investors are looking for alternative places to invest their savings, and with the gains others have made through cryptocurrency it’s no wonder this investment is in the spotlight.

What are the risks with buying cryptocurrency?

All investments have risk attached to them, the reality most don’t think about is the fact risk is actually what makes you money when you invest. Investing into crypto is risky, but so is buying shares, property, and even doing nothing comes with its own risks.

But given the unregulated nature and complexity of the cryptocurrency markets, there are some key risks you should be across if you’re thinking about jumping on the digital crypto bandwagon.

The first big risk to be aware of is the ‘volatility’ or ups and downs in the value of crypto, which is significantly higher than more traditional investments like shares and property.

This volatility risk is driven by a number of factors like the fact positive and negative news (like Elon Musk’s tweets or the threat of regulation) has a heavy impact on market prices, as well as the fact that if a large crypto investor needs to sell their position, this can ‘move the market’ and change prices significantly given most crypto trading platforms or ‘exchanges’ mainly deal with smaller scale investors.

Security breaches and crypto seizures are also a significant price driver.

One tweet from Elon Musk can send crypto up or down. Picture: Odd Andersen/AFP

The next risk involves the fact that most crypto like bitcoin is held in a ‘digital wallet’ which means it is effectively being ‘minded’ for you by someone else.

This is in contrast to a share portfolio in Australia which is held safely by a company regulated under the Australian financial market regulator APRA, where there is next to no risk of your investments going missing.

Another risk is around the fact there are a large number of crypto exchanges that are based out of foreign countries, which can mean that if something goes wrong it can be hard to chase down your cash.

Then given the currency is entirely digital, there’s the risk of a breach by hackers or other groups. This risk is amplified by the fact data (from trend watchers like Cardify) shows over a third of crypto investors don’t fully understand the technology.

This means this particular risk is very real, and one you should manage if you’re thinking about joining the crypto buyer’s club.

A technician inspects the backside of bitcoin mining at Bitfarms in Saint Hyacinthe, Quebec. Picture: Lars Hagberg/AFP

Where cryptocurrency fits in a smart investment portfolio

Even with the above risks, there’s little doubt there are investment opportunities in the crypto market, with long term crypto investors being well rewarded for their support.

The fact there is limited supply of bigger cryptocurrencies like bitcoin and ethereum, coupled with the accelerating broad adoption by big players suggests strong upside potential in the coming years. That being said, if you want to be smart and to be able to sleep at night, it’s important you understand where crypto fits in your investment portfolio.

A big part of answering this question goes back to understanding your risk appetite, what sort of investor you are, and who you have supporting your investment decisions.

If you don’t have a high risk tolerance, if you’re the sort of investor who can fall into the hard-to-avoid herd mentality, or if you don’t have an investment or financial adviser to help you make smart decisions, you might want to reconsider whether crypto is for you.

But if you have your bases covered, understand the risk, and have some good support, my view is that there is a role crypto can play for smart investors.

The wrap

Crypto is an investment that’s constantly in the spotlight, and with that attention there is more and more interest from crypto investors, and potentially a bunch of money to be made. But investing into cryptocurrency also comes with risk, so if you’re thinking about getting involved, do your research so you get the results you want.

Ben Nash is a finance expert commentator, podcaster, financial adviser and founder of Pivot Wealth, and Author of the Amazon Best Selling Book ‘Get Unstuck: Your guide to creating a life not limited by money’.

Disclaimer: The information contained in this article is general in nature and does not take into account your personal objectives, financial situation or needs. Therefore, you should consider whether the information is appropriate to your circumstances before acting on it, and where appropriate, seek professional advice from a finance professional.