For many investors, capital preservation is equally as important as capital appreciation. If you are one of these more risk-averse investors and are considering making an investment in bitcoin, you should read this guide on the risks of investing in bitcoin first.
Is Bitcoin a Safe Investment?
The answer to the question “Is bitcoin a safe investment?” is, quite simply, “No.”
Investments that are considered to be safe are securities such as United States T-bills and government bonds. Bitcoin, on the other hand, is a high-risk asset class, as there are several potential risks that bitcoin investors face when holding the digital currency as an investment.
Regulatory Risk
Currently, bitcoin is largely unregulated in the United States and most other parts of the world. That means that there is no deposit insurance on lost funds, no agency to protect you if transactions go wrong, and no regulatory body that provides clear guidance on how companies and individuals should handle bitcoin transactions. That also means that buying, holding, and transacting in bitcoin is neither legal nor illegal. It is simply unregulated.
This, in turn, poses the potential risk that regulators who are for the most part neutral on the digital currency now could change their minds and start to impose heavy regulations on bitcoin. Alternatively, regulators could decide to ban the digital currency altogether due to its pseudoanonymous feature that has allowed it to be used for criminal activities in the past.
While most regulators are currently open to bitcoin and digital currency innovation, should this positive sentiment turn negative in major bitcoin economies such as the US, China, UK, Australia, and Japan, then the price of bitcoin could very likely suffer as global bitcoin adoption could slow down.
Technological Risk
There are two primary technological risks. Firstly, there is the risk that bitcoin’s current scalability challenges will not be overcome; secondly, there is a small possibility of a so-called 51 percent attack on the bitcoin blockchain.
The bitcoin network has grown so fast in such a short period of time that the bitcoin blockchain is taking longer than usual to process transactions due to the sheer volume of transactions taking place. This is good news because it shows that bitcoin adoption is growing, but it also means that users have to pay higher fees for their transactions to be processed in a timely manner. Currently, numerous participants of the bitcoin network are discussing solutions to fix this problem. However, should the bitcoin blockchain’s scalability issues not be resolved, then the digital currency could lose in market value as higher fees could make it less useful as a spending currency.
The other technical risk of which bitcoin investors should be aware is the so-called 51 percent attack, which refers to one bitcoin mining operation gaining more than 50 percent of the bitcoin blockchain’s mining power. In that case, this bitcoin mining operation could gain control over the blockchain and could reverse transactions as well as engage in double spending. While this may sound like a very scary scenario, the decentralized nature of bitcoin mining operations is designed to prevent that from happening and it is very unlikely for such an event to take place.
Risk of Cyber Theft
There is also the unfortunate risk of cyber theft that can affect bitcoin holders. There have been numerous cases of bitcoin wallets and exchanges getting hacked and user funds being stolen. This is an unfortunate reality of dealing with bitcoin, since the currency purely exists on the Internet and has become a popular target for cyber criminals.
Fortunately for bitcoin investors, this risk can actually be entirely mitigated by storing your bitcoin holdings offline in either a hardware wallet, a paper wallet, or on a computer that is always offline except for the times when you want to transact in bitcoin.
Market Risk
Finally, there is also the risk that other digital currencies could overtake and replace bitcoin as the leading global digital currency. While bitcoin has the first-mover advantage and a strong brand name, there are numerous other digital currencies that offer more payment privacy and faster transaction times. These currencies could eventually overtake bitcoin as the most used online currency. Once bitcoin loses its number one status, the likely resulting drop in the price of bitcoin could be difficult to overcome, especially if another “better” digital currency becomes more popular among merchants and online shoppers.
Bitcoin is a High Risk/High Return Asset
In the investment world, the higher the expected return, the higher the expected risk of an asset or security. This is also the case with a bitcoin investment. Bitcoin has outperformed all major asset classes since its inception, with its price rallying from less than $0.01 per bitcoin in 2009 to nearly $3,000 as of this writing. This rally, however, was also accompanied by a substantial amount of volatility, including intra-day drops of up to 20 percent. As bitcoin matures as an asset class, its volatility is decreasing. However, five to ten percent intra-day price movements in both directions are still a fairly common occurrence. That will likely continue to be the case for bitcoin.
If you want to play it safe and want to store your capital in a secure low-risk investment, then bitcoin is definitely not for you. If, however, you can accommodate a higher level of risk for a small holding of your overall investment portfolio, then making a small investment in the digital currency bitcoin might be the right choice for you.
Your bitcoin holding could potentially enhance your overall investment returns and can act as a diversifier in your portfolio, since it has no correlation to traditional asset classes such as stocks and bonds. Having said that, due to the discussed risks involved in making a bitcoin investment, you should never invest more than you can afford to lose.
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