Investing in Cryptocurrency - Know the Risks

I have seen plenty of articles, blogs, and news stories recently on cryptocurrency, cryptocurrency mining, and the Bitcoin fork. I even have a personal friend who has hopped on the cryptocurrency bandwagon, if you will, and realized many more investors may be considering cryptocurrency for their own portfolios.

From what you may read and hear, cryptocurrency seems to have some potential. But is it the new currency that can eventually replace or co-exist alongside existing currencies? Or is it a designer currency destined to fail like a passing fad?

I can’t see into the future to predict the longevity and success of cryptocurrency (no one can); however, there are several points to consider before investing in it. Here’s what you should know.

Crash Course in Cryptocurrency

Cryptocurrencies are digital currencies that are, for the most part, decentralized, unregulated, and not subject to any government control. In a way, they work like any fiat currency (What is a fiat currency?), as you can exchange dollars for Bitcoin or Bitcoin for pounds sterling or yen.

The biggest difference between cryptocurrency and traditional currencies is that there is no physical representation of the former. A single Bitcoin, the most common and successful cryptocurrency, doesn't exist in the same way that a single dollar bill or a single Euro does. You can't pull it from an ATM or withdraw it from a bank and have a physical coin in your pocket. Instead, it only exists in a digital space.

This means that using digital currencies to purchase goods and services can be problematic. Bitcoin, the biggest and most well-respected cryptocoin, is used almost exclusively as currency on only a few e-commerce websites. Using Bitcoin in the real world usually requires exchanging it for fiat currency.

Cryptocurrency Investment Opportunities

While cryptocoins are digital currencies, many investors have seen opportunities in using it as a speculative investment for the future. As the relative value of a digital coin fluctuates naturally over time, much in the same way a fiat currency does, there is the potential for a return both in the short and long term.

There are a few ways to trade digital currencies; however, the most straightforward way is to purchase a quantity of cryptocurrency using a fiat currency like USD, with the hope it will increase in value. You can then and then sell the cryptocurrency back into USD or other fiat currency. There are only a handful of online digital currency exchanges that let you do this, and many of these exchanges also offer digital "wallets" that will allow you to store your cryptocoins securely.

The Risk of Investing in Cryptocurrency

Be warned, this is a hugely speculative investment. There are a host of cryptocoin vulnerabilities that you need to be aware of. Hackers have gained unauthorized access to digital wallets and cryptocurrency exchanges. As recently as 2016, more than $50 million in Ether was stolen from investors in a fund known as the DAO.

Additionally, cryptocurrency market prices are often highly volatile. The DAO hack previously mentioned caused the price of the cryptocurrency Ethereum to tumble, leading to a violent market correction. Such events can be notoriously hard to predict and following the pulse of the digital currency community can be a daunting task to any investor.

The Bottom Line

Trading and investing in cryptocurrency may have the potential for a big payday, but I can tell you from experience when you see such volatility, press coverage, and your neighbors start giving you advice on when to buy and sell, it’s probably a good idea to pump the breaks.

Crypto investing and trading is a very new market. It requires specialized knowledge that may be inscrutable to the uninitiated. Rampant growth has led to volatility, and while it may seem attractive to invest in digital currencies, this brand new field does have some instability to consider before investing. As with any new investment, be sure the weigh the risk versus reward so you can make the right choice for your situation.