Risks to consider when investing in Bitcoin (or any other cryptocurrency for that matter)

[A Thread] requested by @SledgeWilliam

1. First, I should state that I am in no way an expert on cryptocurrency – I don’t trade it or watch the sector closely by any means. I would just like to lay out some generic risks and why you might (or might not) think about adding this to your portfolio.

2. And again let me clarify what I view as risk – I don’t view risk as solely dictated by price fluctuations (volatility) but rather as the probability of a permanent loss of capital. So that will be the backdrop in my analysis.

3. Regulation Risk

The biggest risk you face when investing in cryptocurrency (in my opinion) is the possibility of harsh regulation. Crypto as it stands is a very new technology that has gone relatively unchecked in its infancy.

4. What does that mean? Well, especially where money is concerned, governments have the power to legislate the crypto you hold to the point where you can’t access it or it becomes completely useless.

5. The government wants to control how they collect taxes, which they’ve pretty much got a good handle on with the money system we have. If you have been receiving large gains on your crypto’s without tax, enjoy it, but Caesar always gets his pound of flesh.

6. Technology Risk

In crypto’s, all things being equal, you might expose yourself to the risk that the crypto you buy today might not keep up with developments and be outdated in a few months. The same thing with penny stocks – how do you know who the winners will be?

7. Hacking Risk

As we saw with the exchange hacks in recent years of Binance and a few others, hackers always stand a chance of breaking through security to access individual or exchange wallets where crypto is kept. Meaning you face the risk of your wallet being hacked.

8. To increase security you could invest in a hardware wallet (basically a USB with a passcode), Cloud Wallets or a paper wallet (which is basically printing out your public and private keys). Obviously, it might help to be a bit tech savvy when it comes to this.

9. Quantum Computing Risk

Many analysts believe that when quantum computers become more mainstream, their computing power will be so great that it will be very easy to brute force hack wallet security keys. This would cause extreme fear and everyone would just sell.

10. This is more speculative but just because it’s improbable, doesn’t mean it’s impossible.

11. Consumer Protection Risk

Since most governments around the world don’t recognize crypto as a valid asset class if you lose your crypto or it gets stolen, who will you complain to? Unlikely your cries will be well heard.

12. Liquidity Risk

Depending on the crypto you buy, there might not be a buyer on the other side of the trade when you go to sell. Thus, thinly traded cryptos might be difficult to get rid of when the time comes.

13. Now, these are just a few, but I believe there are a lot more fundamental concerns to consider underlying each coin depending on its utility, such as business growth and innovation, cash flows, etc.

14. Let’s talk quickly about DCX10 – the infamous crypto ETF in South Africa that everyone buys to quickly diversify and reduce risk in investing in cryptos.

15. And I have nothing against its creators, but there’s no way anyone could justify this as diversification. First, the ETF invests in the top 10 cryptocurrencies by market cap.

16. What no one seems to say after they’ve touted diversification is that Bitcoin makes up 75% of this index, and Ethereum about 12%. So, the top 2 coins make up 87% of the index. No one no matter how much of a bull could justify that as diversified.

17. Now let’s talk correlation. It might be useful if Bitcoin could show some inverse correlation to other common assets in our portfolios such as stocks, bonds, and real estate. The problem with bitcoin is that it’s still relatively new as an “investment asset”.

18. So any correlation we might make are subject to change quite dramatically and unpredictably. However, the trend in recent months seems to be that Bitcoin has gone from a negative correlation with the S&P500 to just above zero.

19. What does this mean? Well for now it looks like Bitcoin is headed to a higher correlation with the US stock market. If that trend continues, it might not be able to be viewed as a hedge or safe haven from stocks.

20. Correlation in such an early asset class, in my opinion, is more or less useless. Crypto in general hasn’t had time to settle into the financial markets, and with all the risks we have no way of saying it’s going to stay.

21. My personal view – Bitcoin and other crypto’s don’t have much utility to me. I know some use this framework to build their products on and I’m sure many could in theory be a functioning business.

22. However, the unregulated freedom these crypto companies (if you can call them that) means you have no way of knowing if they’re actually a legitimate business, and if they collect your money and go sit on a beach somewhere, no one will be there to hear your cries.

23. As an asset worth my investment, I am hesitant. I don’t see it as a very good hedge or store of value (Bitcoin in particular), and the regulation concerns to me are far too risky.

24. That being said, I think the technology itself has a lot of potential and could really be the next informational step for humans. The question will remain, just like the dot com bubble – how do you pick the winners?

25. Thus, if you can stomach the risks, probably the best way to get exposure would probably be through a diversified ETF (depending on your definition of diversification). Because the future is uncertain and most crypto’s are not investments – they are speculations.

26. Keep it only a small percentage of the portfolio and know that it’s highly speculative and you might have to take large price swings (which might be permanent losses) into consideration.

27. I myself am not as much of a gambler. As usual, this is not financial advice, just research and my opinions on investing. Always do your own research and make your own decisions.