Every investment comes with risk. As risks cannot be got rid of, the investor should do everything he can to at least understand them. This principle is of particular importance in the case of a completely unpredictable cryptocurrency market.
Cryptocurrencies can be simply defined as encrypted systems for storing information about funds held by investors. By itself, cryptocurrency does not exist. The only thing that exists is information about it. So one may wonder if there isn't something wrong, or at least strange, in the fact that investors trade something that is not even there. However, on the other hand, there is no harm to the wanter. The real problem arises only when the investor does not understand that this situation may be a source of high risk. After all, an informal agreement concluded between cryptocurrency users, saying that they have any value at all, may cease to function at any time. The more so because no one has ever seen this agreement.
The non-existence of cryptocurrencies has some significant consequences. First of all, it is difficult to find any fundamental factors that could be referred to in order to set their price. Nobody has any idea how much each crypto should cost, so the market is not correcting absurd valuations. Or to put it another way - no valuation is absurd. As a result, volatility reaches levels unheard of in other types of investments, and an unimportant entry on a little-known blog repeated by global agencies may cause fluctuations of several dozen percent. As a consequence of this volatility, cryptocurrencies are useless as means of payment. If we were to settle our daily transactions in bitcoin, we would have to be ready for inflation or deflation of several dozen percent. And not annually, but overnight. We would not be able to make and meet any long-term commitments. When accepting the payment, we would have to be ready that our transaction will turn out to be extremely unprofitable on the next day.
Cryptocurrencies are also exposed to other fairly serious risks. The risk of losing funds in the event of a hacking attack on cryptocurrency exchanges certainly exceeds the risk of losing funds deposited in bank accounts. One should also bear in mind the increasing risk of unfavorable regulations being introduced. Cryptocurrencies creatively circumvent the ancient law which says that only state authorities or entities authorized by them can issue currency. Therefore, if cryptocurrencies are recognized as money, the authorities of various countries may feel threatened and come up with the idea of banning them, which has already happened in China, Egypt, Qatar, Morocco, Bangladesh, and several other countries. If, on the other hand, cryptocurrencies are not money, then there is nothing to prevent taxing the transactions with VAT, which has also been discussed for a long time, also in the European Union. In both cases, the existence of the cryptocurrency market will be put under a very big question mark, and the value of assets that will be more difficult to sell will drop dramatically.
So why do investors love something that does not even exist, and is also associated with such enormous risks? The answer is simple. If we can earn 3 600% on something in five years, the question of whether it exists or not becomes secondary. Bitcoin cost some $ 800 in 2017 and soared to $ 64 000 in February 2022. Other "coins" also recorded huge increases at that time. Therefore, cryptocurrencies have become considered a good investment and a hedge against inflation. This happened exactly when such security was very much needed, and the risks associated with other methods of protecting the value of investments have increased significantly.
Moreover, proponents of investing in bitcoin believe that its value can grow indefinitely because its supply is artificially limited, unlike the supply of traditional currencies which can be printed without limit. At first glance, this reasoning is logical. However, in real conditions, nothing is that simple. Above all, it's important to remember that bitcoin isn't the only possible investment. If investors, for some reason, decide to buy other cryptocurrencies, gold, or real estate, the price of bitcoin will fall, no matter what the ratio of bitcoin to dollars in circulation is. In addition, the world's central banks will have to stop the printing of traditional currencies when high inflation occurs, while new cryptocurrencies can appear indefinitely. So perhaps it is just the opposite of what many investors think. This unlimited supply of cryptocurrencies can lead to their value tending to zero, while the supply of traditional currencies will have to remain within common-sense limits.
Therefore, should informed investors stay away from cryptocurrencies? Not necessarily. High volatility is a problem when we lose money, but it is also a huge advantage when we earn it. So the point is to understand the risk, not to get rid of it. Investing a large chunk of your savings in bitcoin, based on the belief that its price will continue to rise indefinitely seems extremely risky. Conversely, prudent investments made on the basis of a well-thought-out mathematical system will most likely bring more income the greater the volatility.
The historical volatility associated with the instrument should be assessed before any investment decision is made. This assessment is the most important and for some investors even the only component of the investment risk assessment. With high volatility, an investor can reduce risk by using lower leverage or simply invest a smaller proportion of the portfolio in the instrument. The opposite should be done for instruments with low volatility. This means that, in fact, volatility is of very limited importance. Losses or gains can always be high, whatever its level.
And besides, those who think that risks associated with bitcoin are just too high, have a powerful tool at their disposal - short selling. Rather than lecture others about how dangerous cryptocurrency investments are, they should prove that they are right and devise a sensible strategy that will allow them to cash in on the downside. So far, practice shows that it is not that simple. However, if the risk is so great, the price must drop significantly from time to time. Indeed, it often does. If it ever drops to zero, the profits can be huge, as long as there is still a broker that will be able to settle accounts with the investor. But this is a completely different area of risk.