Should we invest in Cryptocurrencies?

Should we invest in Cryptocurrencies?

Built on blockchain technology with cryptographic technique embedded for verification of transactions, cryptocurrency which is also known as digital asset, is gaining immense popularity throughout the world due to its inimitable characteristics. In Malaysia, three digital asset exchange (DAX) operators were approved by the Securities Commission Malaysia in 2019, namely, Luno Malaysia, Tokenize Technology and Sinegy Technology. The value of cryptocurrencies is by and large determined by the supply and demand principle.

The debasement of the U.S. dollar due to the rapid expansion of money supply by the U.S. may have precipitated the massive adoption of cryptocurrencies by institutional investors. As institutional investors scramble to hedge the value of their investments with crypto-investment, individual investors are increasingly perplexed by the unprecedented growth in the prices of cryptocurrencies. At this time of writing, the overall number of cryptocurrencies in the market is 9457 with a total market cap of more than US$ 2Trillion based on the data from CoinMarketCap. Bitcoin remains the most valuable cryptocurrency followed by the Ethereum platform that facilitates smart contracts and cryptocurrency trading.

Bitcoin’s role as digital gold has established itself as a hedge against inflation. 

The question is should an individual investor invest in cryptocurrencies? Is crypto-investment suitable for you based on your risk profile amid the covid-19 pandemic? And if crypto-investment is suitable for you, should you invest in it for the long term? Although there are websites that attempt to demystify cryptocurrencies by providing charts and advice for investors and potential investors, we need to be aware of the risks involved in crypto-investing before we jump onto the bandwagon. As we are bombarded with so much information, our ability to discern the real news from the fake is more important than ever.  By looking into the motivation and the background of the author who covers certain cryptocurrency, we could at least ascertain the impartiality of the news. Authors of certain websites are required to disclose their stakes in cryptocurrencies as part of the information provider’s effort to instil confidence in their readers.  Moreover, certain cryptocurrency is more susceptible to pump and dump tactic by market manipulators that leads to artificial inflation in prices.  

We see many instances whereby some investors invest on the spur of the moment right after a tweet by certain influential figures in the society. This is because individuals could display a tendency to imitate the actions of others due to the sudden impulse signals received by our brain to act. Psychologists coined this as a form of psychological bias which is widely known as “herding behaviour” or “herding attitude” in the literature of psychology. Even the smartest investors may succumb to this bias if they are not careful. When we become familiar with cryptocurrencies, we also tend to have the urge to place bigger bets. This is termed as familiarity bias. This bias if left unchecked, could result in excessive optimism in the cryptocurrencies that are familiar to them. Hence, informed decisions could only be made by understanding the nature of these currencies and on the elements that drive the performance of certain cryptocurrencies.

While the two biggest currencies, Bitcoin and Ethereum may share many similar characteristics, Ethereum is distinctly different from Bitcoin. Bitcoin is simply a form of decentralized money while Ethereum is a programmable money that allows many applications to be built on it by utilizing smart contract not only for payment, but also to provide financial services.

Interestingly, developers are also utilizing the characteristics offered by the blockchain technology to build non-financial related applications which include crypto-games on the Ethereum platform that are trusted with tamper and censorship resistance.  

In contrast, monetary theories seem to imply that cryptocurrencies are lacking the characteristics of the fiat money and thus, they are not real money.

The rise of cryptocurrencies may pose a threat to the stability of monetary system that typically uses monetary policy or tools to control the money supply and inflation. For instance, monetary tools may no longer be as potent as before with the balance of payment of the country no longer reflecting the actual financial health of the country. This ensued from rampant money laundering activities with cryptocurrencies being used as payment conduits via the internet without regulatory restrictions. The prominence and the political hegemony of major currencies of certain countries might be potentially subjugated by the increasing use of cryptocurrencies as well. As cryptocurrencies are not developed based on the premise of economics nor social relationships, they are not considered as liabilities to the monetary authorities such as Central Bank of the country. Simply put, the owner of crypto-investments is not protected by anybody if the cryptocurrencies that they are investing in collapse due to fatal flaws in the crypto platform or other factors.

Lastly, we often hear stories about funds being stolen from investors’ accounts with weak password or funds could not be retrieved due to account owners’ negligence. Hence, before you embark on the world of crypto-investing, be on the lookout for reliable websites that provide reliable information and guidance on how to start investing in cryptocurrencies. Knowing the type of wallet that you need to use to store the currencies and how to protect your account from hackers are important as cryptocurrency is essentially a digital asset that are stored digitally without a central storehouse. You need to conduct your own due diligence about the cryptocurrencies that you intend to invest in as many crypto assets are created in less than three years. These crypto assets are deemed unstable with higher chances to fail and become worthless in no time.

“Before you start to invest in cryptocurrency, think about whether you can tolerate this level of risk.”
External Education Advisor - Dr Audrey Lim
Dr. Audrey Lim Li Chin
Lecturer & a researcher at Multimedia University (MMU) Melaka | Certified Financial Planner (CFP)

Source: Smart Investor Jul / Aug 2021