Before answering that question, I am assuming that everyone is aware of what Bitcoins are, what they are buying into as a product or rather a service. Please look at the reasons that Bitcoins originated, the technology behind it and the reasons that it is being hyped here, Read more.
Let’s look at the advantages and disadvantages that Cryptocurrencies may have:
High Returns: Cryptocurrencies gave extremely high returns to investors both historically from 2009 and also in the recent past in 2020 march when the market bottomed out due to Covid.
Diversification: Cryptocurrency’s correlation with Equity Indexes is low and might give us some portfolio diversification benefits in uncertain times.
Hedge Against Inflation: The main reason cryptocurrency surfaced was that they were to be a hedge against inflation because of the limited supply irrespective of the prices. Unlike the sterling or the US dollar, bitcoin and other cryptocurrencies can’t be devalued by a government or a central bank. Bitcoin is not controlled by any centralized authority and its supply is limited as there can only ever be 21m in existence, Know more.
Highly Volatile: In December 2017, we saw Bitcoin (which was the first brand of cryptocurrency) fall by about 80 % to as low as $3,200. It is extremely susceptible to comments made by key industry leaders. Do remember that the rate volatility was close to 80%. Bitcoins traded between $5,000 to $ 40,000 in a single year (2020).
Difficult to Preserve: Since there is no centralized mechanism, it is almost impossible to recover lost Bitcoin.
Less Liquid: Due to limited supply and limited acceptance it is less liquid than other portfolio options like commodities or gold.
High Returns: Cryptocurrencies gave extremely high returns to investors both historically from 2009 and also in the recent past in 2020 march when the market bottomed out due to Covid.
Diversification: Cryptocurrency’s correlation with Equity Indexes is low and might give us some portfolio diversification benefits in uncertain times.
Hedge Against Inflation: The main reason cryptocurrency surfaced was that they were to be a hedge against inflation because of the limited supply irrespective of the prices. Unlike the sterling or the US dollar, bitcoin and other cryptocurrencies can’t be devalued by a government or a central bank. Bitcoin is not controlled by any centralized authority and its supply is limited as there can only ever be 21m in existence, Know more.
Highly Volatile: In December 2017, we saw Bitcoin (which was the first brand of cryptocurrency) fall by about 80 % to as low as $3,200. It is extremely susceptible to comments made by key industry leaders. Do remember that the rate volatility was close to 80%. Bitcoins traded between $5,000 to $ 40,000 in a single year (2020).
Difficult to Preserve: Since there is no centralized mechanism, it is almost impossible to recover lost Bitcoin.
Less Liquid: Due to limited supply and limited acceptance it is less liquid than other portfolio options like commodities or gold.
Bitcoins are concentrated in a few hands, for instance, ~2% of Blockchain Wallets hold ~95% of the total Bitcoins, and less than 10 miners control 90% of the mining pools. This is an alarming situation. – Mimi Partha Sarathy
Unintended Usage: Unlike other currencies which are used for exchange (to overcome Barter challenges), cryptocurrency is being used for Speculation purposes or for making illegal transfers and transactions. Most of the businesses still do not accept Bitcoins.
Regulatory Risks: Government of India is worried that cryptocurrencies will make it very easy for individuals to launder money, circumventing existing controls.
The Reserve Bank of India (RBI) had even banned banks from processing cryptocurrency-related transactions in 2018 which was later lifted by the Supreme Court. RBI has now shifted focus towards creating a digital version of the rupee in order to replace all other forms of cryptocurrencies, except those issued by the state.
India is also reportedly set to propose a law banning cryptocurrencies, fining anyone trading in the country or holding such digital assets.
Cryptocurrency may have certain benefits but the risks outweigh those benefits. If investing for hedging or diversification, one could consider investing in commodities like Gold. These commodities are much more stable and also available in electronic form like ETFs or bonds.
MIMI PARTHA SARATHY
Managing Director,
Sinhasi Consultants Pvt. Ltd.
Conclusion
We must understand these risks attached to cryptocurrencies and possibly stay away until India’s securities market regulators come up with some rules and notifications around bitcoin. But if you still want to include this instrument in your portfolio, we suggest you look at investing SOME OF YOUR MONEY (only so much, that you can afford to lose completely) on cryptocurrency.
We urge you to have conversations with financial advisors who have seen and navigated these cyclical rises and falls. They are in the best objective position to help you understand and mitigate the risks of letting emotion get the better of you.
We can help you understand how to maximise your investment goals or leave a comment below on your thoughts.
