A Transformational Technology?

The blockchain technology underlying bitcoin and other cryptocurrencies has been hailed as a potential gamechanger for a large number of industries, from shipping and supply chains to banking and healthcare. By removing intermediaries and trusted actors from computer networks, distributed ledgers can facilitate new types of economic activity that were not possible before.

This potential makes for an attractive investment to people who believe in the future of digital currencies. For people who believe in that promise, investing in cryptocurrency represents a way to earn high returns while supporting the future of technology.

A Stable, Censorship-Resistant Store of Value

Another common reason to invest in cryptocurrency is the desire for a reliable, long-term store of value. Unlike fiat money, most cryptocurrencies have a limited supply, capped by mathematical algorithms. This makes it impossible for any political body or government agency to dilute their value through inflation. Moreover, due to the cryptographic nature of cryptocurrencies, it is impossible for a government body to tax or confiscate tokens without the cooperation of the owner.

This property makes cryptocurrency attractive to people who are worried about hyperinflationary events, bank failures, or other disaster scenarios. Bitcoin in particular has attracted attention due to its deflationary and censorship-resistant properties, leading proponents to describe it as “digital gold.”

Potential or Speculation?

While many supporters believe that digital currencies could become part of daily life, the cryptocurrency market is currently dominated by speculative trading. Studies of blockchain activity show that exchange trades remain the most prevalent use for cryptocurrencies—and account for far more economic activity than ordinary trades and purchases. Cryptocurrency skeptics, including Warren Buffett, Bill Gates, and JPMorgan CEO Jamie Dimon have all warned of a potential crypto bubble.

Cryptocurrencies are not unique in being subject to speculative manias and irrational exuberance. Other assets such as cannabis stocks, technology stocks, precious metals, and even houses have also been subject to market bubbles, which ended badly for many investors.

As a new technology, some speculative behavior is to be expected in the cryptocurrency space, especially as blockchain technology matures. However, new investors should be wary of falling into psychological traps such as herd instinct, Fear of Missing Out, or the Greater Fool Fallacy, which can make all the difference between a calculated risk and a foolish one.

Thefts, Scams, and Other Losses

One of the most impressive and unique aspects of cryptocurrency is also a significant liability. Since cryptocurrency does not rely on a central intermediary, it falls on the user to safely store the cryptographic keys which control their blockchain address. Investors who choose to explore the digital currency space should be aware that a number of special security measures are absolutely necessary, and that even those measures may not sufficiently protect their holdings against hackers working constantly to refine their techniques.

Theft remains one of the most common threats to cryptocurrency users, and hackers have stolen tokens worth billions of dollars from exchanges, wallet software, and ordinary users. In addition, there are also a number of schemes to trick users into giving up their tokens, such as doubling scams, social engineering, market manipulation, and even fake ICOs.

But another major threat is the users themselves. Unlike other applications, most digital wallets cannot be reset if you forget the passphrase. Users have lost hundreds of millions of dollars worth of cryptocurrency due to forgotten passwords or lost devices.

The Bottom Line

While it’s clear there are many reasons to be skeptical of digital currencies, many traditional investors have been won over to the new asset class. The blockchain space is frequently described as a transformative industry, with the potential to disrupt the world in the same way that the Internet did in the 1990s.

However, supporters of digital currencies should be careful to understand the risks of cryptocurrency before they start investing. In addition to mastering the complex security protocols and thoroughly researching their new investments, they should also take the time to understand the most common pitfalls that befall novice investors.