You’ve no doubt heard popular cryptocurrencies like Bitcoin and Ethereum discussed as legitimate investment opportunities, and there’s a grain of truth to this sentiment.
But cryptocurrency, both conceptually and in practice, is very complicated. Most people who own cryptocurrency don’t really understand how the underlying principles of cryptography work.
This isn’t a deal breaker. Consumers can use cryptocurrency to buy things, and investors can make money by holding cryptocurrency as its value appreciates, without being able to explain the concept of the blockchain or the mechanics of cryptocurrency keys.
That said, cryptocurrency’s complexity is a source of significant risk, just as the complexity of traditional foreign exchange markets (forex) is a source of risk for people who choose to invest in fiat currencies.
And cryptocurrency offers real benefits both for its users and for the broader economic system. If you’re curious about crypto, you should carefully weigh these upsides against the drawbacks to arrive at an informed decision as to whether to participate in cryptocurrency markets and to what extent.
Pros of Cryptocurrency
The technology behind cryptocurrency is complicated and often a bit of a black box for those who are not experts. Each coin has its own blockchain, its own rules, and any other technology or other developments they have tied to it. It can be hard to keep up.
Despite these differences, whether you are dealing in Bitcoin or altcoins — a collective name for all cryptocurrencies other than Bitcoin (and sometimes Ethereum) — all cryptocurrencies have some basic similarities behind them.
1. Cryptocurrency Networks Are Inherently Secure
Other than the various scams that fool individual investors into parting with their coins, the focus of most conversations about the security of cryptocurrencies is the underlying technology for mining and exchanging the assets.
Bitcoin was designed to be an absolutely secure system, and most currencies have gone on to continue most of the best practices that this first mover demonstrated. The decentralized register that underpins blockchain technology means that if someone were to attempt to hack a cryptocurrency to modify a record or falsify a transaction, they would have to hack the majority of computers involved in the cryptocurrency.
Without doing this, the rest of the register would just correct whatever the hack was. Potential hackers need a majority order to “convince” the system that the fake record was legitimate. In terms of resources, this is unrealistic. To date, there has not been a single successful attack on the Bitcoin network.
Moreover, the act of mining is itself a built-in quality control and policing mechanism for cryptocurrencies. Because they’re paid for their efforts, miners have a financial stake in keeping accurate, up-to-date transaction records — thereby securing the integrity of the system and the value of the currency.
Pro tip: If you’re planning to invest in cryptocurrencies, you can buy and sell through Coinbase. You’ll receive $5 worth of Bitcoin when you sign up for a new account.
2. Mining Is Accessible to Anyone
An advantage of cryptocurrency is there is no barrier to stop you from getting involved. With a few Internet searches, you can set up your computer to start mining coins for you.
With Bitcoin, you are unlikely to make any money mining without a gargantuan rig, but on some lesser-known coins, you might be able to set up your computer to generate some extra money for you without you doing a thing.
3. Price Fluctuations Can Create Huge Profits
The value of a coin is determined based on how rare it is, the effort expended mining them, and the characteristics of a particular coin.
In the course of a single month, the price of a virtual currency can change by over 20%. In normal years, stock trading can see similar changes, but it is less common. Making real money is entirely possible in this environment, but it also means that you can lose a lot with just one small mistake. Prices can have huge swings from any mention of a specific coin on social media.
Some investors, like teenager Erik Finman, were able to buy in early; he bought into Bitcoin in 2011 and managed to turn $1,000 into $1,000,000 over the course of five years on the currency’s early rise to popularity.
Independent trader Javeed Khan got into Bitcoin in 2018, making a few hundred thousand dollars in profits in his first year, showing that solid profits are still achievable even on an established coin’s price swings.
4. Cryptocurrency Behaves Like “Real” Currency
Treating cryptocurrency trading as though it were a currency in terms of your investment approach may prove to be the most useful analog. Many forex strategies can be effectively ported over to cryptocurrency trading, although you may want to note that the volatility of cryptocurrencies is significantly higher.
For example, Market Traders reports an average of 0.5% volatility for traditional currencies and up to 15% for cryptocurrencies. This, coupled with the relatively limited supply of available sellers for any cryptocurrency, presents a challenge that many investors will need to overcome.
5. Cryptocurrency Is a Potential Hedge Against Inflation
Because cryptocurrencies generally have finite supply (limited numbers of coins) built into their source code, they are a natural hedge against inflation. Without the ability to print more coins, economic theory suggests over time the value of anything finite should keep up with rates of inflation. Cash in your savings account will often effectively lose value over time because rising costs mean the dollars saved today will be able to buy you less in the future.
Cryptocurrencies should not be subject to these changes, at least in theory. A word of caution, however: cryptocurrencies haven’t been around long enough to prove themselves as an effective hedge against meaningful real-world inflation the way gold and other “real” assets have, making this advantage more hypothetical than practical.
6. Loosening of Government Currency Monopolies
Cryptocurrency is attractive to people who worry that quantitative easing (central banks’ “printing money” by purchasing government bonds) and other forms of loose monetary policy, such as near-zero inter-bank lending rates, will lead to long-term economic instability that does even more damage than high inflation rates — which are bad but can at least be controlled by national banks like the U.S. Federal Reserve and European Central Bank.
In other words, cryptocurrencies offer a reliable means of exchange outside the direct control of these central authorities, who collectively hold a monopoly on the global money supply. Or they did until the advent of crypto, at least.
Even if cryptocurrency boosters’ dire predictions of fiat-fueled financial calamity don’t come to pass, many economists and political scientists expect world governments to co-opt cryptocurrency — or at least to incorporate aspects of cryptocurrency, such as built-in scarcity and authentication protocols — into fiat currencies. This could potentially satisfy some cryptocurrency proponents’ worries about the unstable nature of fiat currencies and the inherent insecurity of physical cash.
7. Harder for Governments to Exact Financial Retribution
On a more practical level, cryptocurrency makes it more difficult — though not impossible — for illiberal governments to exact financial retribution on dissidents or political rivals. When citizens make trouble for repressive regimes, law enforcement agencies or financial regulators controlled by those regimes can easily freeze or seize bank accounts or reverse transactions made in local currency.
This is not a theoretical concern. In autocratic countries such as China and Russia, wealthy individuals who run afoul of the ruling party frequently find themselves facing serious financial and legal troubles of dubious provenance. These troubles often result in property seizure, forced nationalization of private businesses, and prison time.
Unlike central bank-backed fiat currencies, cryptocurrencies are virtually immune from authoritarian caprice. Cryptocurrency funds and transaction records are stored in numerous locations around the world, rendering state control — even assuming international cooperation — highly impractical. It’s a bit of an oversimplification, but using cryptocurrency is a bit like having access to a theoretically unlimited number of offshore bank accounts.
Decentralization is problematic for governments accustomed to employing financial leverage or outright bullying to keep troublesome elites in check. Unsurprisingly, those governments are fighting back. In 2021, per CoinDesk, the Russian government banned public officials from holding cryptocurrency, supposedly as part of a broader anti-corruption initiative.
8. Crypto Transactions Are Generally Cheaper Than Traditional Electronic Financial Transactions
The concepts of blockchains, private keys, and wallets effectively solve the double-spending problem, ensuring that new cryptocurrencies aren’t abused by tech-savvy crooks capable of duplicating digital money. Cryptocurrencies’ security features also eliminate the need for a third-party payment processor — such as Visa or PayPal — to authenticate and verify every electronic financial transaction.
In turn, this eliminates the need for mandatory transaction fees to support those payment processors’ work — since miners, the cryptocurrency equivalent of payment processors, earn new currency units for their work in addition to optional transaction fees. Cryptocurrency transaction fees are generally less than 1% of the transaction value, versus 1.5% to 3% for credit card payment processors and PayPal.
9. Cryptocurrency Can Reduce the Cost of International Transactions
Cryptocurrencies don’t treat international transactions any differently than domestic transactions. Transactions are either free or come with a nominal transaction fee, no matter where the sender and recipient are located.
This is a huge advantage relative to international transactions involving fiat currency, which almost always have some special fees that don’t apply to domestic transactions — such as international credit card or ATM fees. And direct international money transfers can be very expensive, with fees sometimes exceeding 10% or 15% of the transferred amount.
Cons of Cryptocurrency
Any time you invest money, you are putting it at risk. Bitcoin trading is in many ways like trading a currency or a stock. You are trying to buy at a lower price than you eventually sell at.
Stocks have intrinsic value and dividends that they can give you, and U.S. dollars and other major currencies are backed by central banks. But there aren’t the same tethers for cryptocurrencies.
This contributes to cryptocurrencies’ high levels of volatility. They can be good as either a short-term investment or a long-term one, in the right hands.
1. Cryptocurrencies Are Extremely Volatile
Cryptocurrencies are volatile. It is hard to explain how volatile they are. As an example, businessman and entrepreneur Elon Musk mentioning reservations about Dogecoin, after initially voicing his support to the currency, threatened as much as a 70% change in price. Most of this discussion that sent Dogecoin prices on a roller coaster took place on Twitter in a series of tweets over the course of a week.
Making real money is entirely possible in a volatile trading environment, but it also means you can lose a lot with just one small mistake.
Not being controlled by central banks means a coin’s value is whatever buyers on the open market will pay. But it also means there’s nothing tethering any cryptocurrency’s value to reality, and any coin could theoretically become worthless in an instant if demand for it goes away.
As with any investment, diversification is your best bet. Putting everything into a single coin or trying to win big in an initial coin offering (ICO) can make you a lot of money, or you could lose your shirt. Everything in cryptocurrency is high-risk, and you should behave accordingly.
2. Cryptocurrency Scams Abound
Even the most legitimate seeming company in the cryptocurrency space is more volatile and at risk than those in other industries. And there are still many who hope to scam the unwary.
American technology company Ripple Labs Inc. developed and launched the digital currency XRP to allow financial institutions to use its Ripple payment/exchange network, aimed toward offering an alternative way to process day-to-day transactions.
Ripple offered what it claimed was a secure system of cross-border transactions. Its operations were based on XRP, and the company hoped it would be able to take down SWIFT, the current system for most banking transactions. XRP joined the host of cryptocurrencies being traded on various cryptocurrency exchanges such as Coinbase.
The Securities and Exchange Commission (SEC) disagreed and filed suit against Ripple, claiming the company had violated securities regulations. The SEC argued Ripple’s XRP was not a real cryptocurrency, and instead a way to functionally defraud investors. As of May 2021, Ripple remains operational as the legal process plays out, but the uncertainty generated by the SEC’s action certainly clouds the company’s future.
3. Cryptocurrency Is Less Liquid Than Fiat Currency or the Stock Market
Even the best cryptocurrency exchanges do not hold a candle to the liquidity that is tied to any stock market.
Institutional investors in more established markets create price walls by putting a lot of orders into the system at prices surrounding the current range of trading prices. This means a single big order tends to move the price less, as a lot of other automated trading happens around each big move.
In nearly all cryptocurrency markets, these price walls have not yet been established. A single large investor selling their crypto can cause a major swing in market prices as they go through filling the orders from the best price downward. This raises the volatility higher than it would be otherwise because sudden trades can lead to price shocks.
This risk piles atop the currencies’ existing everyday volatility to create further shifts in the market.
4. The Regulatory Environment Is Constantly in Flux
An area that needs to be watched is the changing laws around cryptocurrencies. In previous years, cryptocurrencies have been taxed at a relatively generous rate and governments have been largely hands-off.
Recent actions suggest that this time may be at an end, including President Biden tapping Janet Yellen — a noted cryptocurrency skeptic — as Treasury Secretary, the SEC filing suit against Ripple, and coin issuer Tether and the Bitfinex exchange paying $18.5 million to settle a legal dispute in New York, per The Block. Together, these actions suggest regulators are skeptical of the industry and paying it greater attention.
New regulations may require reporting from either individuals or exchanges or even by the creators of certain coins. This may drastically change the market. Any market change can make or break fortunes in an evening.
5. Cryptocurrency Wallets and Exchanges May Have Security Flaws
The weak point in cryptocurrency’s security is with the user. Although the Bitcoin network itself remains unhacked, a number of the surrounding software tools that interact with the network have been infiltrated and misused.
If someone gets into your cryptocurrency wallet, they can steal your coins. That has nothing to do with the security of the cryptocurrency as a whole. The same goes for if a trading exchange is hacked — you could lose out big through no fault of your own.
Exchanges are the platforms that serve as the easiest way to trade different cryptocurrencies, analogous to the app or platform you’d use to buy and sell stocks. If a hacker is able to send a directive to the exchange to conduct a transaction, they do not need to hack the cryptocurrency. Instead, their fraudulent order will read as a legitimate transaction and will be accepted by the rest of the blockchain.
This is famously what happened to Mt. Gox, a cryptocurrency exchange that operated from 2010 until 2014, when a hacker was able to pose as an auditor for the site and authorize transactions. Accounts with more than $8 million in Bitcoin were affected.
Many companies hide or downplay the disclaimers around this. As a result, the supremely secure Bitcoin network isn’t worth a hill of beans if the surrounding infrastructure is full of holes.
6. There’s No Recourse for Digital Asset Recovery
There are tens of thousands of dollars of real money locked in computers because the owners do not know how to recover them. Maybe they forgot a key password, or maybe they forgot that they have a couple of Bitcoin they once bought as a joke.
Once you take your cryptocurrency off a trading platform and into your own control, you are the sole person responsible for it. If you lose your private keys, the coins are gone for good. If your coins are stolen, there’s no way to track them down and generally no recourse for recovering them.
Likewise, if an unscrupulous seller cheats you in a cryptocurrency transaction — perhaps by demanding upfront payment for goods they never intend to send — you have no legal means to claw back your funds.
Though some newer cryptocurrencies attempt to address this significant weakness, solutions remain incomplete and largely unproven. For now, cryptocurrency users simply can’t count on being able to recover lost or stolen coins.
By contrast, fiat currency users have plenty of protections, although none are totally foolproof. Banks have insurance that can protect your funds in case they fail. Stock markets have regulations that prevent a number of shady dealings from going on, and brokerages carry insurance in case they fail as well. Fiat currency processors and credit card networks such as Visa, Mastercard, and PayPal resolve buyer-seller disputes through chargeback policies that are specifically designed to prevent seller fraud.
7. Mining Coins Requires Serious Resources
Making serious money from mining requires a commitment of time and money. You will need to prepare a serious set of hardware, with many creating specialized computers or servers for the task. Even then, you need to pick a coin that you can make money from, instead of never realizing your investment.
The energy-intensive nature of cryptocurrency mining is problematic for another reason: It’s very bad for the environment.
The biggest culprit is Bitcoin, the world’s most popular cryptocurrency. Although Bitcoin boosters point out that Bitcoin mining only consumes a small fraction of the energy of the global financial sector, it’s inarguable that Bitcoin has a massive carbon footprint relative to its reach and utility. The Cambridge Centre for Alternative Finance estimates that Bitcoin accounts for more than 0.5% of global energy output, a fact made worse by the fact that some of the world’s largest Bitcoin mines are located in largely coal-powered countries like China and Russia.
Although they’re quick to throw cold water on the most alarmist claims, cryptocurrency experts acknowledge that mining presents a serious environmental threat at current rates of growth. Ars Technica identifies three possible short- to medium-term solutions:
- Reducing the price of Bitcoin to render mining less lucrative — a move that would likely require concerted interference into what’s thus far been a laissez-faire market
- Cutting the mining reward faster than the currently scheduled rate (halving every four years)
- Switching to a less power-hungry algorithm — a controversial prospect among mining incumbents
Over the longer term, the best solution is to power cryptocurrency mines with low- or no-carbon energy sources, perhaps with attendant incentives to relocate mines to low-carbon states like Costa Rica and the Netherlands.
8. Crypto and Blockchain Are Fertile Ground for Hucksters
Blockchain technology is relatively new and hard to understand. As a result, it is often marketed as a modern-day snake oil that can cure all ills. Some fraudsters have argued that their new technology based on the blockchain will replace credit cards or reshape an industry, only for them to disappear with investors’ money.
Even well-intentioned people with big ideas for using the blockchain can get investors into trouble. Several companies and celebrities have announced plans to create their own coins or other products based on the blockchain, but the viability of any of these ventures remains to be seen.
If an investment opportunity that makes big promises based on “blockchain technology” sounds too good to be true, it may well be.
9. Cryptocurrency Has High Potential for Tax Evasion in Some Jurisdictions
Because cryptocurrencies aren’t regulated by national governments and usually exist outside their direct control, they naturally attract tax evaders. Many small employers pay employees in Bitcoin and other cryptocurrencies to avoid liability for payroll taxes and help their workers avoid income tax liability, while online sellers often accept cryptocurrencies to avoid sales and income tax liability.
According to the IRS, the U.S. government applies the same taxation guidelines to all cryptocurrency payments by and to U.S. persons and businesses. However, many countries don’t have such policies in place. And the inherent anonymity of cryptocurrency makes some tax law violations, particularly those involving pseudonymous online sellers, difficult to track — as opposed to an employer who puts an employee’s real name on a W-2 indicating their Bitcoin earnings for the tax year.
10. Lack of Regulation Facilitates Black Market Activity
Probably the biggest regulatory concern around cryptocurrency is its ability to facilitate illicit activity. Many gray and black market online transactions are denominated in Bitcoin and other cryptocurrencies. For instance, the infamous dark web marketplace Silk Road used Bitcoin to facilitate illegal drug purchases and other illicit activities before being shut down in 2014. Cryptocurrencies are also increasingly popular tools for money laundering — funneling illicitly obtained money through a “clean” intermediary to conceal its source.
The same strengths that make cryptocurrencies difficult for governments to seize and track allow criminals to operate with relative ease — although, it should be noted, Silk Road founder Ross Ulbricht is now behind bars, thanks to a years-long DEA investigation. Ulbricht, also known by the pseudonym Dread Pirate Roberts, unsuccessfully appealed his life sentence in 2017, according to WIRED.
Final Word
Investing in cryptocurrencies can help to pad your bank account, but realizing high gains requires work. In order to outcompete everyone else trying to buy low and sell high, you need something on your side.
Maybe that’s time spent doing research to plan each of your moves. Maybe it’s a willingness to take an extremely long view, holding out through all the roughest periods during which everyone else sells.
Your best bet is to apply the same fundamental principles and process you would with any other investment: knowing your own risk, understanding the pros and cons, and trying to make your own determination about whether and to what extent to participate in the market.
Above all else, resist the temptation to see cryptocurrency as a get-rich-quick opportunity and don’t invest more than you can afford to lose. Blockchain technology certainly looks as though it may be the next gold rush, and you’d do well to remember that those who tend to do the best in a gold rush are the ones who sell pickaxes.
