Whether you believe in cryptocurrencies or not, you can’t help but notice the rising interest in this digital coin.
In this article I will address the question of ‘are cryptocurrencies a good investment?’, but before I do, I think it’s important that we address the question of what is a cryptocurrency and is it potentially the future of money?
If you are looking to invest your money in anything it’s important to have an understanding in the asset. After all what creates value in anything is determined by the simple economic principle of Demand and Supply. i.e. with a fixed supply of an asset, an increase in demand will naturally increase the price. Equally, with an increase in supply but static or a reduction in demand, it will reduce the price.
With cryptocurrencies, the supply is already addressed (fixed by the coin provider). The main unknown is Demand. We will address this based on the distinction of short-term demand and long term demand,but firstly lets clearly define exactly what is a cryptocurrency?
What is a Cryptocurrency?
A cryptocurrency in simplistic terms is a digital currency that works through a decentralised exchange. i.e. it takes away the middle man (like a bank), that is required with traditional cash.
Bitcoin was the first digital currency (and is still the most important as of today). This was created in 2009 anonymously by a person going by the name of Satoshi Nakamoto. The identity has never been found although there has been a lot of speculation on who this person is.
Investing in Cryptocurrencies
There are literally thousands of cryptocurrencies in existence now so it can be challenging to understand the difference between different cryptocurrencies, and to decide which coins might be good for investment. We will address the different types of Cryptocurrencies in a future article coming soon.
But before you even look at the different coins, its important that you understand the risks associated with crypto, and the potential reward.
Why are cryptocurrencies so volatile?
We already mentioned Demand and Supply earlier in the article. I also referenced the distinction between short-term demand and long-term demand.
The truth is, volatility is often created by uncertainty. People buying rumour’s and rushing in not to miss out. This can be referred to as short term demand.
You must be careful not to get swayed by other people’s opinions. Unfortunately, there are a lot of people looking to take advantage of people’s greed and the whole pump and dump play (common in penny stocks), is certainly very prominent in cryptocurrencies. In other words, people buying a lot of a coin and then using social media to promote it to a huge following only to then dump it for a huge profit whilst the poor guys getting in at the end take a big loss. This is very common, and you must never follow someone else’s advice. Always do your own research.
Risks and Potential Rewards
There is no denying that the blockchain technology that most crypto coins operate under, is far superior to what we currently use today. Things can be done faster, cheaper and with a lot less risks of middleman interference and error.
However, there are still a lot of unknown variables. For example, are cryptocurrencies potentially a replacement for traditional money? If you ask the government then this will be a resounding no. Governments won’t easily relinquish control of their currency. So,it’s inevitable that regulation will be introduced (which creates additional unknowns).
But the potential is huge. It’s a little like the dot com era where only a few companies survived and became global giants.
The internet was new and Amazon and Google we’re worth cents, but the dramatic rise of the internet changed that. Facebook overtook MySpace and now we are in an era where cryptocurrencies could one day have a similar impact as the internet did back then.
Is it worth the risk?
This really comes down to your risk appetite. There is no doubt that the volatility and risks are high. But if you can find a project that will be backed with long term demand (solving real life problems in big markets), then the potential reward is astronomical.
My advice is if you are going to invest, do your research and invest only with money you can afford to lose.
In future articles we’ll be speaking more about the core things you need to learn about in order to find the best opportunities in cryptocurrency investing.