There are many misconceptions about cryptocurrency that are detrimental to the investor but before we dive into some of the misunderstandings of cryptocurrency from an investor's perspective, we must first define cryptocurrency itself.
The most straightforward definition I came across was published by Merriam-Webster: Cryptocurrency is "any form of currency that only exists digitally, that usually has no central issuing or regulating authority but instead uses a decentralized system to record transactions and manage the issuance of new units, and relies on cryptography to prevent counterfeiting and fraudulent transactions."
Cryptography is basically the act of transmitting data in secret code so that only the intended sender and receiver can read and process the information. In other words, cryptography is utilized to add an additional layer of cybersecurity to a specific set of data. Bitcoin is arguably the most commonly known form of cryptocurrency but there are many other types such as litecoin, ethereum, zcash, and so on.
Cryptography: Secure transactions?
Gavin Andersen, bitcoin's technical lead, told Forbes.com that cryptocurrency is designed to bring back a "decentralized currency of the people," taking centralized banks out of the equation. This may sound good on the surface but underneath what this really means is that cryptocurrency transactions are anonymous and untraceable, which further means that it is nearly impossible for the government or any type of regulatory authority to monitor this environment.
This is precisely the meaning of decentralization in regard to cryptocurrency. Many cryptocurrency advisors "sell decentralization" to investors as an upside, but in actuality, this is where the problem starts...
The absence or lack thereof of a centralized regulatory authority means that payment processors and law enforcement have no jurisdiction over cryptocurrency. In other words, cryptocurrency is an extremely risky endeavor for you as the investor because you are not legally protected in the event where a cryptocurrency advisor misappropriates the use of your funds for their best interest instead of yours.
Therefore, the lack of a regulatory authority for the cryptocurrency space is not an upside as many cryptocurrency advisors will tell you. It is actually a clear-cut downside for the investor. The untraceable nature of cryptocurrency has created a niche for illegal activity such as drug trafficking, fraudulent transactions, and false or fake initial coin offerings (ICO) and so on.
In February of 2018, the U.S. Commodity Futures Trading Commission (CFTC) joined other regulators in the quest to warn investors on the "pump-and-dump" cryptocurrency investing schemes. Additionally, CFTC published a statement saying "customers should not purchase virtual currencies, digital coins, or tokens based on social media tips or sudden price spike."
According to news.bitcoin investors lose an average of $9.1 million per day to cryptocurrency scams, and that number is growing by the day.
The worst part about this is that the innocent investor cannot take any legal action against these scams because there are no centralized authorities who are regulating this toxic environment. According to an article published by WIRED.com in January of 2018, Facebook announced that it will be banning cryptocurrency advertising from its platform entirely. A few months later in March of 2018 Google joined Facebook in banning cryptocurrency ads.
Google's Director of Sustainable Ads Scott Spencer cited the "unregulated and speculative" nature of financial products being advertised such as cryptocurrency as an example of "new threats" to the Google user experience. So ask yourself, "if major corporate institutions such as Facebook and Google are completely disassociating themselves from cryptocurrency to protect their users, then why would you as an individual investor invest your hard-earned capital into this highly unregulated, fraudulent and unprotected space?"
Sophisticated or Speculative Investor?
The other major downside of cryptocurrency is that this space is arguably one hundred percent speculative. To get a better understanding of this lets quickly compare a sophisticated investor versus a speculative investor.
The main difference between a sophisticated and speculative investor is the degree of risk undertaken in the endeavor. A speculative investor is not exactly equivalent to but is largely similar to gambling such as placing your money into a slot machine, crossing your fingers and praying for good luck. Speculative investors are typically seeking to gain an abnormally high return in a relatively short amount of time on substantially high-risk bets that can go one way or the other, which is essentially a "get-rich-quick scheme."
Sophisticated investors typically partake in lower-risk investments seeking a reasonable return over a period of time based on fundamental analysis and intrinsic value diagnosis.
An example of a speculative investor is one who will consider a new tech company that has an equal chance of skyrocketing in a short-time period or going bankrupt.
With no historical data of this company's performance, a sophisticated investor will tend to shy away from such a risky investment. On the other hand, a speculative investor may believe that the new tech company is going to strike gold and may buy its stock purely based on a "gut-feeling. This would be speculation, (i.e. cryptocurrency).
As a side note, the vast majority of get-rich-quick strategies have historically not withstood the test of time.
Now don't get me wrong, as I am well aware that some investors have amassed a fortune from cryptocurrency just as those lucky ones who have won big at the casino. The risky nature of cryptocurrency can in many cases be compared to the risky nature of playing the slot machine or the crap table.
From an investor's perspective, all I ask is that you at least think twice before investing your hard-earned capital into cryptocurrency by weighing out the risks that are associated with this endeavor.
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Disclaimer: Hudson Wealth Management, LLC (HWM) is a FINRA registered investment adviser firm. Investing in securities involves risks, and there is always the potential of losing money when you invest in securities. Before investing, consider your investment objectives and HWM's fee schedule. The information provided herein is for illustrative purposes only and does not constitute personalized investment advice, recommendations or solicitations to hold, buy or sell any investment or security of any kind. All images and return figures shown are for illustrative purposes only and are not actual customer or model returns. Past performance does not guarantee future results.
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