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Explained: Why most investment experts recommend against investing in cryptocurrency

By Finserv MARKETS - Aug 3,2019
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Explained: Why most investment experts recommend against investing in cryptocurrency

What will we see first: Dow 30,000 or Bitcoin $30,000?”

Bitcoin’s rollercoaster ride after hitting $17,000”

How High Can Bitcoin’s Price Go in 2018?”

All these headlines appeared in 2017, the height of cryptocurrency mania. Judging only by the headlines, it would seem that cryptocurrencies should be an indispensable part of a good portfolio and the most popular of all—Bitcoin—would have touched $35000, if not $50000 by 2019. The reality, however, is slightly different. Bitcoin is trading near $8000 in June, it was hovering around $4000 in April. Though it has nearly doubled in three months, cryptocurrencies are highly unpredictable digital assets. Bitcoin may well touch $4000 by July.

What is a cryptocurrency?

A cryptocurrency is a virtual currency which uses encryption techniques to ensure the security of transactions and regulate the generation of units. Cryptocurrencies are based on a distributed ledger system enforced by an independent network of computers. The defining feature of a cryptocurrency is its immunity from government manipulation as it is not regulated by any central authority. Buying popular cryptocurrencies such as Bitcoin, Ripple, Litecoin, and Ethereum have been gaining currency with investors, but the strategy is fraught with risks. Financial experts have been warning against investing in cryptocurrencies. Let us take a look at some of the reasons.

Explained: Why most investment experts recommend against investing in cryptocurrency

Volatility

Sometimes the biggest allure becomes the biggest weakness. Many investors are primarily attracted towards cryptocurrencies due to their organic nature or their independence from regulators. Since digital currencies are not controlled by a central authority, their volatility cannot be curtailed. As more and more people rush in to buy virtual currencies, their prices shoot up, creating a bubble waiting to burst.

Explained: Why most investment experts recommend against investing in cryptocurrency

Nascent Technology

The technology behind digital currencies is relatively new, with the first cryptocurrency—Bitcoin—coming into existence just 10 years ago. The distributed ledger system, or the blockchain technology, that supports major virtual currencies is still evolving. With so many changes taking place, no one can predict with surety the final version of the technology. Investors should be cautious and approach digital currencies after proper due diligence.

Unregulated

The virtual currency market is largely unregulated and in case of fraud, investors cannot approach a regulating authority for grievance redressal. We can approach the Securities and Exchange Board of India in case of a stock market fraud, or Insurance Regulatory and Development Authority if there is an issue with an insurer, but there is no redressal system in place for cryptocurrencies. This essentially means that if an investor is squeezed of his money through unethical means, it is almost impossible to get the money back.

Issue of Legality

The legal status of cryptocurrencies in India is still unclear. Though investing in digital coins has not been declared illegal, the Reserve Bank of India has barred entities regulated by it from providing services related to cryptocurrencies. “Such services include maintaining accounts, registering, trading, settling, clearing, giving loans against virtual tokens, accepting them as collateral, opening accounts of exchanges dealing with them, and transfer or receipt of money in accounts relating to purchase or sale of virtual currencies,” the central bank has said in a circular.

If recent reports are to be believed, the Indian government may well ban virtual currencies and people holding or dealing in digital coins may face a jail term of 10 years. Another issue with digital currencies is the taxation process. In 2017, the income tax department had sent notices to around 500,000 cryptocurrency investors for non-payment of taxes. The tax rules on gains from trading in virtual currencies, just like the legal status, is ambiguous. However, if you want to avoid income tax notices, consider investing in mutual funds. Mutual Funds are not only a relatively safer investment, but some investments are also tax exempted. Investors can choose from a wide variety of mutual funds on Finserv MARKETS’ user-friendly portal.

Limited Use

The utility of blockchain technology, the backbone of cryptocurrencies, has been credibly proven, but the same cannot be said for digital coins. Digital coins are considered to be a futuristic form of monetary exchange by many people, but very few establishments consider it a legal tender, severely limiting its utility. Moreover, speculative trading in virtual coins has diminished the line between being a currency and being a tradable commodity. Digital currencies are not backed by any underlying assets and therefore do not have intrinsic value like gold or land. This leads to wild fluctuations in its value, which is a big impediment for it to be considered a valid form of currency.

Explained: Why most investment experts recommend against investing in cryptocurrency

Conclusion

Cryptocurrencies like Bitcoin have gained widespread popularity and acceptance amongst investors, especially after 2017, but it does not make investing in it less risky. Just like other financial assets, you should always conduct proper research before putting your money in digital currencies. The golden rule of investing—don’t invest if you don’t understand—gains more importance in the case of cryptocurrencies. If you are looking for safer investing options, consider investing in mutual funds. Small amounts invested in good mutual funds can give significant returns in the long term.

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