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Cryptocurrency has gained popularity over the past decade, often touted as the future of finance and a revolutionary investment opportunity to some. However, beneath the dazzling allure of the possibility of high returns lies an often volatile and speculative market fraught with potential risks. Prudent investors beware, cryptocurrencies can wage war and cause potential destruction to your financial future.
The Volatility Trap
Cryptocurrencies are notorious for their extreme price volatility.1 Such dramatic swings can be attributed to speculative trading, regulatory news, and market sentiment, which can create an unpredictable environment that resembles gambling more than investing. Even the so-called crypto “experts” advise only investing about 5% of an overall portfolio in cryptocurrency, citing the high volatility of cryptocurrency markets and the potential to lose it all.1
Unlike more traditional investment vehicles, which derive value from underlying businesses or cash flows, cryptocurrencies lack intrinsic value. Their worth is primarily driven by supply and demand dynamics, often fueled by hype and speculation rather than fundamental financial performance.2 This volatility makes it challenging to rely on cryptocurrencies for consistent returns or long-term success.
Regulatory Uncertainty
The regulatory landscape for cryptocurrencies is uncertain and still evolving. Regulatory actions can have immediate and profound impacts on cryptocurrency prices. For instance, China’s crackdown on cryptocurrency mining and trading in 2021 led to notable market disruptions.3 Inconsistent and unpredictable regulatory environments add another layer of potential risk for investors.
In the United States, while the Securities and Exchange Commission (SEC) has not banned the trading of cryptocurrency, they have made significant strides to enforce regulations consistent with other trading platforms.4 In 2024, the SEC brought 46 enforcement actions related to cryptocurrency against 124 defendants, the largest number in a decade.4
Moreover, the lack of regulatory oversight has made the cryptocurrency market a hotbed for fraud and scams. The Federal Trade Commission (FTC) warns investors to be cognizant of such scams and report popular tactics among scammers, according to the Federal Trade Commission, are individuals or businesses only accepting payment in cryptocurrencies, guarantees of profits or big returns, scammers pretending to be celebrities promoting cryptocurrencies, and online “love interests” requesting money through cryptocurrency, and more.5 Such incidents highlight the vulnerabilities and potential risks associated with investing in cryptocurrencies.
Environmental Concerns
Cryptocurrency mining, particularly Bitcoin, consumes vast amounts of energy, raising significant environmental concerns. The process of mining involves solving complex mathematical problems, which requires substantial computational power and, consequently, electricity. According to the Cambridge Bitcoin Electricity Consumption Index, Bitcoin, the world’s largest cryptocurrency, consumes an estimated 150 terawatt-hours of electricity each year – equivalent to the country of Argentina, which has a population of 45 million people.6
This massive energy consumption contributes to carbon emissions and environmental degradation, making cryptocurrencies an unsustainable investment choice.7 Investors with a focus on environmental, social, and governance (ESG) criteria may find cryptocurrencies at odds with their values and investment goals.
Security Risks
The digital nature of cryptocurrencies can make them susceptible to cyberattacks and security breaches. The decentralized and often anonymous nature of these transactions can make it difficult to recover lost or stolen assets.8 Additionally, the irreversible nature of most cryptocurrency transactions means that errors or fraud can result in permanent financial loss.8 The high-profile hacks of exchanges like Coincheck or Bithub, where investors lost significant sums, underscore the security risks inherent in cryptocurrency investments.8
Lack of Consumer Protections
Traditional financial systems offer various consumer protections, including insurance on bank deposits and regulatory oversight of financial institutions. In contrast, the cryptocurrency market operates with minimal consumer protections. If an exchange is hacked or goes bankrupt, investors have little recourse to recover their funds. The decentralized nature of cryptocurrencies, while providing certain potential benefits, also means that there is no central authority to appeal to in cases of fraud or theft.8
Market Manipulation
The relatively low liquidity of many cryptocurrencies compared to traditional assets can make them more susceptible to market manipulation. Large trades or coordinated buying and selling by a small number of individuals can cause price swings.9 The infamous “pump and dump” schemes, where the price of a cryptocurrency is artificially inflated before being sold off by the manipulators, leaving ordinary investors with significant losses, are a testament to the potential risks of market manipulation in the crypto space.9
While the allure of potential high returns from cryptocurrencies can be tempting, cryptocurrencies remain a potentially risky investment option for investors. The speculative nature of cryptocurrencies contrasts sharply with a prudent portfolio. At Matson Money, we are committed that investors operate from academic investing principles that can help save them from speculating and gambling with their financial future.
Instead of getting swept up in the hype, investors can focus on three simple rules: own equities, diversify and rebalance. We are training and developing investors to be vigilant investors, to stay disciplined, and stick with the science of investing. If you want to learn more about academic investing principles to have confidence in your long-term investing strategy, join us for our breakthrough educational event, the American Dream Experience.
DISCLOSURES:
This content is based on the views, opinions, beliefs, or viewpoints of Matson Money, Inc. This content is not to be considered investment advice and is not to be relied upon as the basis for entering into any transaction or advisory relationship or making any investment decision.
All of Matson Money’s advisory services are marketed almost exclusively by either Solicitors or Co-Advisors. Both Co-Advisors and Solicitors are independent contractors, not employees or agents of Matson.
Other financial organizations may analyze investments and take a different approach to investing than that of Matson Money. All investing involves risks and costs. No investment strategy (including asset allocation and diversification strategies) can ensure peace of mind, guarantee profit, or protect against loss.
PAST PERFORMANCE IS NO GUARANTEE OF FUTURE RESULTS
Sources:
- Tambe, Nikita and Jain, Aashika. Why I s the Crypto Market Down Today? Forbes Advisor. Published June 10, 2024. Retrieved 13 June 2024 from https://www.forbes.com/advisor/in/investing/cryptocurrency/why-crypto-market-is-down/.
- Kelleher, John. Why Do Bitcoins Have Value? Investopedia. Published April 10, 2024. Retrieved 14 June 2024 from https://www.investopedia.com/ask/answers/100314/why-do-bitcoins-have-value.asp.
- John, Alun, Samuel Shen and Tom Wilson. China’s top regulators ban crypto trading and mining, sending bitcoin tumbling. Reuters. Published September 24, 2024 from https://www.reuters.com/world/china/china-central-bank-vows-crackdown-cryptocurrency-trading-2021-09-24/.
- SEC Continues to Regulate Cryptocurrency Through Record-High Enforcement Efforts. Published February 26, 2024. Retrieved 14 June 2024 from https://www.troutman.com/insights/sec-continues-to-regulate-cryptocurrency-through-record-high-enforcement-efforts.html#:~:text=SEC’s%20Cryptocurrency%20Enforcement%20Efforts&text=In%202023%2C%20the%20SEC%20brought,individuals%20and%2046%25%20were%20firms.
- What To Know About Cryptocurrency and Scams. Federal Trade Commission. Retrieved 14 June 2024 from https://consumer.ftc.gov/articles/what-know-about-cryptocurrency-and-scams#scams.
- Bitcoin Network Power Demand. Cambridge Bitcoin Electricity Consumption Index, University of Cambridge. Retrieved 14 June 2024 from https://ccaf.io/cbnsi/cbeci
- Hinsdale, Jeremy. Cryptocurrency’s Dirty Secret: Energy Consumption. Published May 4, 2022. Retrieved 14 June 2024 from https://news.climate.columbia.edu/2022/05/04/cryptocurrency-energy/#:~:text=Bitcoin%2C%20the%20world’s%20largest%20cryptocurrency,of%20Argentina%2C%20population%2045%20million.
- What to know about cryptocurrency and cybersecurity risks. City National Bank. Retrieved 14 June 2024 from https://www.cnb.com/personal-banking/insights/cryptocurrency-cybersecurity-risks.html.
- Das, Lipsa. What is a Pump and Dump. Ledger Academy. Published November 22, 2023. Retrieved 14 June 2024 from https://www.ledger.com/academy/what-is-a-pump-and-dump-in-crypto.