Although cryptocurrencies have become a more mainstream investment in recent years, they still remain highly controversial, with both ardent supporters and critics. On one side of the debate, you have investors like Elon Musk who are open about owning them and view them as the way of the future. Squarely on the other side you have other influential leaders like Warren Buffet and Christine Lagarde, who have been warning investors about the multitude of risks involved with trading cryptocurrencies.

A cryptocurrency is a form of digital currency that lets you make online payments directly to other people or businesses without having to go through a third-party like a bank. Records of these transactions are logged onto a public ledger called a blockchain, which is transparent and shared among all users in a permanent and verifiable way. There are currently over 9,000 different types of cryptocurrencies, but Bitcoin is by far the largest, with its’ market capitalisation equal to that of nearly all other top cryptocurrencies combined.

Unlike so-called fiat currencies such as the US dollar and the euro, which are managed and backed by central banks, cryptocurrencies are decentralised instruments, meaning that no single entity has control over how they are governed. Instead, they are driven by consensus and the peculiarities of the cryptocurrency itself. For example, bitcoins are “mined” using high-powered computers that solve exceedingly complex mathematical problems. However, by design, only 21 million bitcoins can be mined, making them a finite resource more akin to certain commodities than a printed currency.

Bitcoin and other cryptocurrencies are highly speculative investments, since supply and demand drive their volatility – not intrinsic value. Cryptocurrencies don’t have earnings or revenues. They don’t have a price-to-earnings ratio or book value. Traditional value metrics do not apply and a such, there are no methods for assessing their value. Naturally however, as their value increases, this success attracts new investors and prices can soar. But on the flip side, a single negative event or even a tweet can drive prices down just as quickly.

As long as cryptocurrencies are subject to high volatility, it seems likely that they will have only limited use as a viable currency. Another barrier to broader public acceptance as a true currency is that, as cryptocurrencies become more widespread, the risk of regulation probably will rise – eliminating part of their appeal to those investors who perceive them as a currency not controlled by central bank policy or national governments.

Because the value of cryptocurrencies is currently not tied to the value of a basket of goods or services, their value as an inflation hedge is a matter of speculation and is unpredictable. Since last year, cryptocurrencies experienced both sharp rallies and sharp price declines even though inflation data consistently ticked higher. Whether cryptocurrencies will prove to be an effective inflation hedge in the long run is thus yet to be determined.

It is highly suggested that investors who are interested in cryptocurrencies approach them as speculative investments and consider their goals as well as the risks involved. For those who already have a diversified portfolio and a long-term investment plan, it could make sense allocating a very small part of their portfolio to cryptocurrencies. However, in the case of small or relatively new investors who may be tempted by cryptocurrencies simply because of their buzz or in search of a quick profit, they should take a step back and consider the myriad risks involved, including the fact that the value of even the most popular cryptocurrencies have been volatile, the market isn’t very transparent, investor protections are inadequate, and regulations are insufficient.

Disclaimer: This article was written by Stephen Borg, Head of Private Clients at Calamatta Cuschieri. The article is issued by Calamatta Cuschieri Investment Services Ltd and is licensed to conduct investment services business under the Investments Services Act by the MFSA and is also registered as a Tied Insurance Intermediary under the Insurance Distribution Act 2018.

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