Are Cryptocurrencies Safe Investments?
Cryptocurrencies have attracted a reputation as unstable investments, due to high investor losses as a result of scams, hacks, and bugs. Although the underlying cryptography is generally secure, the technical complexity of using and storing crypto assets can be a major hazard to new users.
In addition to the market risks associated with speculative assets, cryptocurrency investors should be aware of the following risks:
User risk: Unlike traditional finance, there is no way to reverse or cancel a cryptocurrency transaction after it has already been sent. By some estimates, about a fifth of all bitcoins are now inaccessible due to lost passwords or incorrect sending addresses.
Regulatory risks: The regulatory status of some cryptocurrencies is still unclear, with many governments seeking to regulate them as securities, currencies, or both. A sudden regulatory crackdown could make it difficult to sell cryptocurrencies, or cause a market-wide price drop.
Counterparty risks: Many investors and merchants rely on exchanges or other custodians to store their cryptocurrency. Theft or loss by one of these third parties could result in the loss of one's entire investment.
Management risks: Due to the lack of coherent regulations, there are few protections against deceptive or unethical management practices. Many investors have lost large sums to management teams that failed to deliver a product.
Programming risks: Many investment and lending platforms use automated smart contracts to control the movement of user deposits. An investor using one of these platforms assumes the risk that a bug or exploit in these programs could cause them to lose their investment.
Market Manipulation: Market manipulation remains a substantial problem in the cryptocurrency space, and some exchanges have been accused of manipulating prices or trading against their customers.
Despite these risks, cryptocurrencies have seen a major leap in prices, with the total market capitalization rising to over $1 trillion.
Despite the speculative nature of the asset, some have been able to create substantial fortunes by taking on the risk of investing in early-stage cryptocurrencies.
Advantages and Disadvantages of Cryptocurrency
Cryptocurrencies were introduced with the intent to revolutionize financial infrastructure. As with every revolution, however, there are tradeoffs involved. At the current stage of development for cryptocurrencies, there are many differences between the theoretical ideal of a decentralized system with cryptocurrencies and its practical implementation.
Some advantages and disadvantages of cryptocurrencies are as follows.
Advantages
Cryptocurrencies represent a new, decentralized paradigm for money. In this system, centralized intermediaries, such as banks and monetary institutions, are not necessary to enforce trust and police transactions between two parties. Thus, a system with cryptocurrencies eliminates the possibility of a single point of failure, such as a large bank, setting off a cascade of crises around the world, such as the one that was triggered in 2008 by the failure of institutions in the United States.
Cryptocurrencies promise to make it easier to transfer funds directly between two parties, without the need for a trusted third party like a bank or a credit card company. Such decentralized transfers are secured by the use of public keys and private keys and different forms of incentive systems, such as proof of work or proof of stake.
Because they do not use third-party intermediaries, cryptocurrency transfers between two transacting parties are faster as compared to standard money transfers. Flash loans in decentralized finance are a good example of such decentralized transfers. These loans, which are processed without backing collateral, can be executed within seconds and are used in trading.
Cryptocurrency investments can generate profits. Cryptocurrency markets have skyrocketed in value over the past decade, at one point reaching almost $2 trillion. As of May 2022, Bitcoin was valued at more than $550 billion in crypto markets.
The remittance economy is testing one of cryptocurrency's most prominent use cases. Currently, cryptocurrencies such as Bitcoin serve as intermediate currencies to streamline money transfers across borders. Thus, a fiat currency is converted to Bitcoin (or another cryptocurrency), transferred across borders, and, subsequently, converted to the destination fiat currency. This method streamlines the money transfer process and makes it cheaper.
Disadvantages
Though they claim to be an anonymous form of transaction, cryptocurrencies are actually pseudonymous. They leave a digital trail that agencies such as the Federal Bureau of Investigation (FBI) can decipher. This opens up possibilities of governments or federal authorities tracking the financial transactions of ordinary citizens.
Cryptocurrencies have become a popular tool with criminals for nefarious activities such as money laundering and illicit purchases. The case of Dread Pirate Roberts, who ran a marketplace to sell drugs on the dark web, is already well known. Cryptocurrencies have also become a favorite of hackers who use them for ransomware activities.
In theory, cryptocurrencies are meant to be decentralized, their wealth distributed between many parties on a blockchain. In reality, ownership is highly concentrated. For example, an MIT study found that just 11,000 investors held roughly 45% of Bitcoin's surging value.
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One of the conceits of cryptocurrencies is that anyone can mine them using a computer with an Internet connection. However, mining popular cryptocurrencies requires considerable energy, sometimes as much energy as entire countries consume. The expensive energy costs coupled with the unpredictability of mining have concentrated mining among large firms whose revenues running into the billions of dollars. According to an MIT study, 10% of miners account for 90% of its mining capacity.
Though cryptocurrency blockchains are highly secure, other crypto repositories, such as exchanges and wallets, can be hacked. Many cryptocurrency exchanges and wallets have been hacked over the years, sometimes resulting in millions of dollars worth of "coins" stolen.
Cryptocurrencies traded in public markets suffer from price volatility. Bitcoin has experienced rapid surges and crashes in its value, climbing to as high as $17,738 in December 2017 before dropping to $7,575 in the following months.
Some economists thus consider cryptocurrencies to be a short-lived fad or speculative bubble.
