Have you been looking to ride the current investment craze of bitcoin? With the dramatic increases in value of this form of cryptocurrency over the last year, many investors are having significant FOMO (fear of missing out) and wondering if there’s still time to make some serious money.
Before you jump into the cryptocurrency pool – or any other new investment arena, for that matter – make sure you understand all aspects of the market, particularly the risks that you are being exposed to. An uneducated investor can quickly become nothing more than a foolish gambler, with poor prospects for a financial windfall.
What is bitcoin?
According to the Oxford dictionary, bitcoin is a type of digital currency in which a record of transactions is maintained and new units of currency are generated by the computational solution of mathematical problems, and which operates independently of a central bank.
Merriam-Webster defines it as a digital currency used in peer-to-peer transactions. Introduced in 2008, it quickly became the most prominent of a group of virtual currencies – money that exists mainly as a computer code and has no central issuing authority.
Bitcoin is not backed by any government, nor is it supported by a hard asset like gold, silver or platinum. Its fluctuating value is linked in part to a scarcity that is mathematically predetermined. Unlike other forms of digital cash, bitcoin is truly untraceable and therefore, like cash, cannot be recovered if lost or destroyed.
The vulnerabilities of cryptocurrency
There are two key points of vulnerability with bitcoin and other cryptocurrencies: price volatility and hacking. With the former, bitcoin went from spectacular price increases in 2017 to a 50% decline in 2018, making this a very risky investment for those hoping to make a quick – and lucrative – turn on investment.
But what has really kept bitcoin investors up at night is the problem of hacking. Novices in this new field viewed bitcoin as actually a safer investment because of the digital nature of the currency. However, the digital currency has been anything but hacker-proof. Hundreds of millions of dollars’ worth of digital currencies have been stolen by hackers just in the last several months. Just a few of the most significant incidents:
- In January, Japanese exchange Coincheck said hackers stole more than $500 million worth of cryptocurrency.
- In June of this year, South Korean exchange Coinrail announced that cyber thieves had stolen 30% of the company’s virtual currencies.
- Also in June, Bithumb experienced a cryptocurrency hack valued at approximately $31 million dollars.
- In 2017, two bitcoin exchanges went bankrupt after falling victim to security breaches.
There are numerous other incidents of investor loss tied to bitcoin cybercrime and little has been achieved to regulate and protect virtual currencies. Different countries are implementing different measures, which further complicates the situation.
For example, China has tried to ban trading in bitcoin, while Japan has officially recognized bitcoin as legal tender and started licensing exchanges. In the U.S., the Securities and Exchange Commision has been increasing its scrutiny of digital assets, but regulation has been sporadic at best.
The investor at greatest risk
The average individual – particularly those who know little about cyber currency but simply want to make a fast return on their investment – are at the greatest risk for losing it all. They tend to put all, or a significant amount, of their investment dollars into one platform out of convenience and misguided trust.
If these companies are hacked, as many have been, the investor is often left with nothing because few are able to compensate their investors for the loss. While Bithumb and Coincheck claim to have reimbursed their investors out of their own funds following their hacks, this is not sustainable over the long term.
Major investors, like banks and insurance funds, are less vulnerable because they spread their risk over a number of platforms, as well as across a large number of assets like stocks and bonds, consumer and commercial loans and mortgages. Eventually, however, the cryptocurrency market will have to figure out how to close the security points of vulnerability if it hopes to survive and become a thriving investment marketplace.
Until then, it is wise for the individual investor not to invest in bitcoin or other digital currencies. Unless you are an expert in the area, can tolerate high price volatility, and are comfortable with high levels of risk, particularly related to securing your holdings, put in only an amount of money where you are prepared to lose it all.