How safe is it to invest in cryptocurrency? I see bitcoin going up almost every time I look at its market value. How can anyone be sure it wouldn't crash in the future?
How can anyone be sure it wouldn't crash in the future?
You can't. There is no perfect safety in investing. And even investments that are considered pretty safe (like government bonds) are exposed to inflation risks.
For cryptocurrencies specifically, this is a highly speculative asset class. Right now, many people are buying on the hope that this will increase further. Yet nobody knows whether cryptocurrencies will ever be useful for anything besides speculation. The throughput and the transaction latency of many cryptocurrencies are definitely not appropriate for a currency. And this is already ignoring that cryptocurrencies suffer from extreme volatility so far.
These things combined raise many red flags that this might be an example of the greater fool theory and therefore a speculative bubble. Anyways, bubble or not, if you are afraid of crashes, this is way over your risk tolerance due to the high volatility.
Additionally cryptocurrencies seem to have quite a lot of issues with fraudulent exchanges, wallets being hacked, etc. which adds another layer of risk.
I would even argue about the usage of the word "investment".
There is a difference between gambling and investment. If you buy a cow because it produces milk, it's an investment. You invested money in it, and every day your cow will give you milk, and you can drink the milk, or sell the milk, so it will keep producing you value day after day. If the price of cows drops, you won't lose your investment, you can still keep producing milk. If you buy a stock at a company which produces useful products, you'll have a profit because that company keeps producing value. However, if you purchase something which doesn't produce anything, and you only bought it because you hope it will increase in value and you'll be able to sell it later to someone else for even more money, then it's not an investment, it's speculation. It's similar to day trading, which is a zero-sum game. It doesn't produce any value. If your guess is lucky, you'll get rich, if you guessed wrong you'll get broke.
One of the most visible arguments against looking at Bitcoin as an investment is the reaction of people who are into Bitcoin, when they encounter criticism such as the one above. They instantly get defensive, and try to convince us about how wrong we are and how great Bitcoin is.
If you have a cow, and your income is the milk it produces, you don't have to convince other people about how great it is to own cows, you don't have to convince other people that they themselves should buy cows. If fact, it would be detrimental for you to do so, as this could drive the price of cows upward, and that will hurt you if you want to expand your business later by buying more cows. Similarly, if you find a company which is not well known, but you see they make products which are useful, and you feel the company will have a great future, and you buy some stock in that company, in order to profit from the value they make by making and selling products, you don't need to advertise this. In fact, it's better for you if you keep your predictions about how big this company will get, as a secret, so that you'll be able to keep buying their shares cheaply. Your income doesn't depend on convincing other people how great that company is. Yet in the case of Bitcoin (or tulips in 1630's Netherlands) you desperately need to convince people how great your "investment" is, because you desperately need the price to keep climbing. And yes, Bitcoin does have its uses, but the price it is traded by today is orders of magnitudes higher than what it would really be worth if it was merely used for its original claimed purpose. It will likely have its uses even after the bubble bursts, just as tulips are nice flowers and are still grown and traded. But all who invested all their savings into them when they cost orders of magnitude more than what they're really worth, will lose most of their money.
About how "useful" bitcoin is in itself: it has serious issues preventing its long term success. It uses so much energy, and as time passes and the blockchain grows, the cost of transactions will keep increasing. It will not be economical to use it for everyday grocery shopping. And as mining gives, by design, diminishing returns, what will keep miners interested in validating transactions once the rewards for mining are getting below a certain point? Of course, this might not lead to the end of Bitcoin itself, it might still have its uses, but everyday grocery shopping will not be it, once it will cost several megawatts of power to buy a single bread. (as of writing this, one transaction is almost one MWh, and it just keeps growing. you don't have to pay for it now because miners still keep mining, but that won't be forever, by design)
But even if Bitcoin was as useful as its proponents claim?
Apples (the fruit) are useful. They are nutritious, healthy, and taste good. You can buy one for less than a dollar, and it's a dollar well spent. But what if one day you suddenly find out that a single apple costs 500 dollars? And the next day it costs 1000 dollars. You might think "had I used all my money yesterday to buy apples, I could sell them now and could have doubled my money." Maybe you'll feel you should buy an apple now for 1000 dollars, and hope that tomorrow it will cost even more, and then you'll turn a hefty profit. But if you try to justify your decision by the fact that apples are nutritious, healthy, and taste good, you'd be lying to yourself, because it's not the usefulness of the apple as a fruit what drives you to "invest" in them.
Similarly, although Bitcoin certainly has its uses, these uses are not what drives the vast majority of people to keep buying them. They buy them because they have seen how fast the price is climbing, and they hope that it will keep doing so at the same rate. This is called a financial bubble.
I remember, when Bitcoin first came out, looking at the technology involved and saying "this will never amount to anything other than one big scam." Turns out I was wrong: it's become a fractal scam, with smaller scams inside the big scam and smaller scams still inside of those. But one thing it has never become is a currency of any kind:
A currency is characterized by four fundamental features. To qualify, it must be unit of account, must be a standard for deferred payment, must be a store of value, and must serve as a medium of exchange.
Since Bitcoin’s source code predetermines that Bitcoin’s supply will ultimately be fixed and totally inelastic, all market adjustments can take place only via price changes, not quantity changes. As a result, it is destined to be inherently subject to extreme price volatility. This means that Bitcoin will never serve as a reliable unit of account. You will rarely see items with Bitcoin price tags attached. You will also never see deferred contracts (contracts under which payment is made under a long-term credit arrangement) written in Bitcoin. Can you imagine someone writing a mortgage contract denominated in Bitcoin?
Bitcoin’s volatility also renders it unattractive for most corporations to hold in lieu of cash reserves. Indeed, Bitcoin, which is considered an intangible (something, incidentally, that brings inconsistent and opaque accounting treatment in its wake), throws considerable risk on to balance sheets. In short, it is not a reliable store of value. It’s no surprise, therefore, that most corporations are unwilling to take on the risks associated with holding Bitcoin on their balance sheets. A recent survey found that roughly 5 percent of finance executives said that “they planned to hold bitcoin as a corporate asset in 2021” and “84 percent of respondents said they did not plan to ever hold bitcoin as a corporate asset,” citing volatility as their foremost concern.
Furthermore, very few items are purchased with Bitcoin. Items are not only not priced in Bitcoin, but the transaction costs associated with Bitcoin are excessively high for both buyers and sellers.
Bitcoin clearly falls short of meeting the four standard criteria to be designated as a currency. Accordingly, it should not be viewed as a currency but as a speculative asset with a fundamental value of zero.
The wild promises cryptocurrency was sold to the public on have never materialized, and almost certainly never will, given that their realization is fundamentally incompatible with the nature of a blockchain. The only thing that has gotten any traction using crypto as a currency is crime, with everything from illegal drugs to child pornography to ransomware unlocks being denominated in crypto these days.
Remember, "the market can remain irrational longer than you can remain solvent." Betting on a bitcoin crash any time soon is probably not a particularly good idea. But neither is betting on it to continue growing. Your best course of action is simply to avoid it altogether. Especially if what you're looking for is safety!
No, for some values of safe.
While other answers have pointed out that no investments are really safe, cryptocurrencies have an almost unique capacity to go to zero in a short space of time.
Crypto currencies base their value absolutely on trust, in that people trust the maths behind them to ensure their scarceness and the exclusivity of their transfer. If this trust fails, perhaps by a 51% attack or quantum computing, their value could easily become zero in the time it takes for people to figure out what is going on, which could be minutes.
I agree with all of the answers that say cryptocurrencies, like all investments and/or gambles sit on a Risk Continuum, i.e., they have varying levels of risk relative to one another.
More important though is the risk to you. That depends on a few factors including:
1- Your Age, or how many years until you'll need to liquidate investments to finance living expenses (if ever)
2- Your other investments, if any. What % of your overall investments/wealth/savings would an investment or speculation in a cryptocurrency represent? Would losing 100% of that particular investment force lifestyle changes now or in the future?
3- Your ability to invest in a disciplined, unemotional way... consistently. See the "caveat" in the paragraph immediately following #5 below.
4- What you're trying to accomplish. Are you trying to "get rich quick"? Or build a portfolio you expect will pay your expenses when you have to or want to stop working? Finance a near-term expense? Long-term? Leave money to your heirs? These are all important factors in determining what's "risky" vs relatively "safe", which leads to,
5- YOUR actual risks. This one is often overlooked. Wall Street firms and most financial intermediaries, advisors, and articles referring to Risk treat it as if it's synonymous with Volatility (as measured by the Standard Deviation of returns over time). While I agree that Volatility is or can be a risk, it is not Risk. Let me repeat that: Volatility is not Risk. In fact, Volatility is far more frequently the source of extraordinary returns. For instance, price volatility in dividend-paying, growing, and other high cash flow securities can dramatically increase your returns over long time frames, assuming reinvestment. Whether the securities pay dividends or not, and whether you reinvest those dividends automatically or not, Volatility can still work to your advantage through opportunistic investment or reinvestment.
In the long run Volatility in quality investments works in your favor. There is a huge caveat here, though: Volatility will cause extremely poor investment results if you are simply speculating or gambling and not actually investing in things you know and understand. It will cause you to be shaken out of otherwise high probability long-term investments due to your emotions, i.e., your Fear of the Pain from Financial Loss. According to Prospect Theory-- the development of which earned a Nobel Prize for Daniel Kahneman and Amos Tversky-- we experience the pain from losses about twice as strongly as the joy from gains. While that might not seem like much, it goes a long way towards explaining the terrible investment results of the vast majority of investors, especially those repeatedly buying high and selling low at the tail end of bull runs. Knowing what you're doing and what you're putting your money into are the only things you can do to take emotion out of your decision-making process. It doesn't belong there. If you haven't mitigated the emotional effects of a price drop or crash prior to buying a security, your greatest risk isn't from the security, but yourself. And that risk is called: Permanent Loss of Capital.
That leads us to the risk to you from putting money in Bitcoin and other Cryptocurrencies.
First, I'd encourage you to read up on what Bitcoin is intended to be as well as the probability that BTC or any other crypto will see adoption hit the critical mass needed to realize this goal (or something close to it). Second, I'd encourage you to understand what other cryptocurrencies are, or are trying to be, and finally, how both Bitcoin and other cryptocurrencies are currently being viewed and used.
I was a sceptic for a very long long time. Now, while I'm no fanboy, I do see the potential benefit of holding Bitcoin and possibly one or two other cryptocurrencies (max). This has nothing to do with the current price run-up, though. I'm less concerned with Price than I am with Value. My interest in Bitcoin wouldn't be as the currency they originally intended it to be, but as a Store of Value serving as an Inflation Hedge. This is similar to the way many people feel about Gold and other precious metals that were once used as currencies or currency bases at certain times in the past.
While it's possible that Bitcoin could evolve to be a currency, I find it much more likely to evolve as a Store of Value. Right now it's being used purely as an Investment Asset.
Why do I think it has the potential to develop as a store of value? Because of the strict limit on supply. There will never be more than 21 million Bitcoin in circulation. From there it's a simple matter of math: if I own something that's supply-limited and accepted as being a thing of value its price in local currency (any flexible fiat currency) will appreciate with that currency's inflation rate, at a minimum.
Basically, Bitcoin has the potential to develop into a "better Gold". It has this potential to be better than Gold as a store of value because of its 1- singularity of purpose, 2- intangible nature, and 3- security features. Gold has carry and exchange costs that an intangible store of value wouldn't. Gold is also being mined continuously, with new supply being discovered all of the time. There is no cap to the amount of Gold. Even if its growth is minimal or can be safely assumed to not grow any more than a few %/year on average, Gold's growth plus carry & exchange costs combine to be a significant drag on its functionality as a store of value.
[For those criticizing both Fiat Currencies and Cryptocurrencies as being based on nothing more than trust: that's the case with everything we've ever used to trade or store value. Yes... Gold, too. Gold produces nothing, costs you to hold, is impractical in everyday use, etc. The only reason its been used as currency at times in the past is because people agreed that it had value. Whenever the times called for it something other than Gold stored value. It only has value insofar as we agree it has value, just like anything else that produces nothing of value itself. Imagine: the world collapses... no governments, no security, etc. What would be valuable in this world? Gold? I don't think so. How about: Water, Food, Ammunition, etc.? Ancient Rome paid its soldiery with Salt! Can you imagine salt being more valuable than gold? It's happened.]
Of course, as others have pointed out Bitcoin has or might have problems with its security features or because of its security features, and faces not-insignificant risks from governments around the world. Should security fail, then the value would be lost, completely. Should financial intermediation add to the costs of holding or transacting in Bitcoin, then the value would suffer (depending on degree). Should Bitcoin or any other other cryptocurrency present or be perceived as a threat to any large country's currency or revenue base it runs the risk of being forced out or underground. I don't know how that shakes out, but it is a risk. For any of these risks the probability of total loss is very high and the potential for such losses is very real.
So, what is the Risk of buying Bitcoin or another cryptocurrency? Right now the only cryptocurrency I see developing as a store of value is Bitcoin (and maybe Ethereum). The primary risk to owning Bitcoin that I see is not Volatility itself, but from volatility functioning as a catalyst to poor decision-making under conditions of uncertainty. Most people either don't know what they own, buy it purely for speculation, and/or can't afford to lose the money committed. As such, they are easily shaken out of their positions at a loss.
Bitcoin can and will be extremely volatile, especially for the foreseeable future since its current price is based more on speculation than anything else.
So, the real Risk of buying Bitcoin is that you'll lose everything you invest and possibly more than you can afford to lose. That's almost completely dependent on your behavior in response to short-to-medium term volatility, though. I say *"almost completely dependent" because your behavior is itself dependent on several factors, such as: your knowledge of the product and securities trading/investing in general, your own finances, and the other risks and assets in your life that inform your Fight or Flight response.
But current pricing and the proliferation of cryptocurrency alternatives to Bitcoin has very little to do with their value as currencies or stores of value. Its more of a "piling in" to products that present an opportunity to capitalize on a price-insensitive public's appetite for anything, any tradable thing, to appreciate in value... quickly. usually, it's Wall Street that does this. They respond to demand and "give the people what they want", dancing as long as the music's playing then absconding with profits and bonuses when the edifice collapses. This time it's come from a different area... but it's the same story. Buying into anything other than the most widely-adopted coin (by both retail investors and institutions/large companies) carries far more risk of permanent impairment of capital, i.e., losing all of the money you invest.
Current pricing in this area is somewhat of a game of "Hot Potato" fueled more by FOMO (Fear of Missing Out) than good sense or investing prowess. This makes people price-insensitive, forcing what's called Greater Fool Investing to take precedence in markets. Greater Fool Investing is when you have no idea what something's worth (the Value), but believe there's a greater fool than yourself out there who will buy it from you at an even higher price. When that's the case, it's best to either be patient or only risk what you can afford to lose today, meaning what you can afford to lose that will have no impact on your lifestyle now or in the future.
There are a few reasons to be careful about investing in cryptocurrency.
"Get rich quick" schemes are a bad idea
Anything that seems like it could make you a lot of money easily and quickly should be approached with a lot of caution.
This is especially true if we're talking about the finance industry, where there are many people with many years of experience trying to profit from even the smallest opportunity or inefficiency in the market (which tends to reduce or remove that opportunity, meaning others can't profit from it).
If you see something that seems like an amazing investment opportunity, that may be the case, but it's more likely that you're missing something.
Investing in any individual stock or instrument is considered high risk
The price of single stocks, currencies or financial instruments can increase significantly, but they are also much more likely decrease significantly.
There are a few cryptocurrencies, so you can get some diversification by investing across them, but that's still not much better as they all carry the risks associated with crypto.
Unless you're an experienced trader, I would strongly recommend investing across not only different instruments, but also different industries, to decrease your investment risk. I would also advise against trying to pick and choose stocks to invest in. There are ETFs and funds for this purpose.
Or, if you want to invest like this, treat it as gambling and only invest money you're willing to lose in its entirety.
Crypto is relatively new
Bitcoin has been around for little over a decade, which isn't that long for a company, but it's especially not very long for a currency. Crypto also doesn't have the advantage of being the official currency of some country. There are some places that accept it, and some larger companies have committed to it, but it hasn't yet gained widespread acceptance.
That means there's still a lot of uncertainty about where it's going, and uncertainty is bad for investing.
Crypto is very volatile
The uncertainty around crypto can also be seen in its price.
Bitcoin reached almost $20k in 2017 before plummeting and staying around half that price or lower, and only recovered 3 years later in 2020.
Just in the last year the price increased to 1000% of what it was. During that time it also dropped from $40k to $30k before climbing to $57k and dropping to $45k.
Those are some huge ups and downs.
Is this just another momentary peak before it plummets again, will it keep going up or will it remain where it is? It's all just speculation.
Crypto has no inherent value
A conventional company typically provides some service or product that people want. This service or product is something people actually get. They have assets that can be sold. They have a customer base that provides some guarantee of future income. This can all fall apart fairly quickly, but there is at least something.
Crypto, on the other hand, is a rather complex interaction of whether people think it's potentially useful, whether people think other people will think it's potentially useful, whether people will continue to think this and whether all those people will commit to it at some roughly overlapping period of time for it to gain widespread acceptance. Then enough people need to continue being committed to it indefinitely for it to keep having value.
You can own all the Bitcoin in the world, but it would be completely worthless if no-one is willing to accept it as payment.
Regulation can cripple crypto overnight
A conventional company is certainly also at some risk of this, and some more than others. But the risk here probably typically isn't quite as big as the risk with crypto.
Crypto represents a large disruption to the finance industry. Countries are still figuring out exactly what regulation makes sense. In theory a large country could create regulation to make crypto usage impossible or impractical, which may cause anyone in that country to get rid of their crypto and/or stop mining crypto, the decrease in demand will cause the price to drop, which may cause others to sell their crypto, other countries may follow suit and this could snowball into most people giving up on crypto.
Note: this snowball effect can happen even without regulation if some big players decide to give up on it for whatever reason.
Past performance is not indicative of future results
This is a common saying in finance.
Just because a price increased up to now doesn't mean it will keep increasing.
It could keep increasing, but it could also have reached a high and decrease, or it could just stay the same.
It is a nice idea to think you can increase your money by 10x in a year by checking what happened in the last year, but you can also lose most of your money instead.
To understand where the price will go, you need to understand what made the price increase, evaluate how likely those factors are to remain relevant, understand what might make the price decrease and evaluate how likely those risks are. That's not easy to do, even the most skilled investors often get this wrong and this is likely even more difficult with crypto since its value is pretty much entirely based on what other people think it's worth without any inherent value to base that on.
Perhaps it may be helpful to describe some of the major currencies by market-cap:
Bitcoin - Transfer fees in the double-digits make it essentially useless as a currency and a way to store value. In addition, its supply is still increasing.
Ethereum - Its claimed use-case is a platform for running decentralized applications ("smart contracts"), which have not proven themselves to be very useful. Fees are usually in the single-digits for pure transfers, but in the double-digits if you wish to use the functionality of a decentralized application, which reduces its usefulness still further.
Binance Coin - Created by the cryptocurrency exchange Binance, it is essentially a clone of Ethereum implemented in a completely centralized way - it is debatable whether it can even be called a cryptocurrency. Regardless, one unit of value on Binance's database is currently worth 520 USD, for a total market-cap of $80 billion.
XRP - Its creators and distributors, Ripple Labs Inc., were recently charged by the SEC for the unregistered selling of $1.3 billion in XRP to retail investors. Although the cryptocurrency has transfer fees in the sub-cent range, it enforces a minimum account balance of 20 XRP in order to make transfers, or about 33 USD.
Tether - A centralized cryptocurrency issued by the company Tether, closely affiliated with the cryptocurrency exchange Bitfinex, it claims to be backed 1-to-1 by USD and to be equal to it at all times, but was recently investigated by the NYAG, who found that this was a lie at multiple points in Tether's history.
The list of course continues... but what I believe you will find, if you continue to research the field of cryptocurrencies, is that their value is not backed by anything true, any real-world usage as a useful system. The cryptocurrency market is pure speculation, which makes it an incredibly high-risk field to invest in.
You might like to take a look at this:
This seems to be an example of fear of missing out, people want to buy in before the price goes up again. But since bitcoin has no underlying assets, and costs a lot in electricity to produce, is quite easily lost if your software backup fails, and is only worth something if other people are willing to put their hard currency into it subsequent to you, it fails to qualify as an investment. If you invest in mining bitcoin yourself, you will only get paid (in more bitcoins) if you hit on the correct hash that enables adding to the blockchain. Otherwise someone else gets the bitcoin and you expended valuable energy for nothing. What's more, so many people are doing it there is a tremendous shortage of graphics cards etc taken up with carrying out an activity which is essentially useless.
But nobody can admit that given the $1T value invested in Bitcoin.