5 reasons to tread carefully in cryptocurrencies
Rampant speculation and a virtual gold rush of so-called ICOs -- or initial coin offerings -- have U.S. securities regulators issuing a chorus of warnings about the dangers of investing in cryptocurrencies.
"Investors should go beyond the headlines and hype to understand the risks associated with investments in cryptocurrencies," said Joseph P. Borg, president of the North American Securities Administrators Association (NASAA) and director of the Alabama Securities Commission on Thursday. "Cryptocurrencies and investments tied to them are high-risk products with an unproven track record and high price volatility."
Investor interest in the cryptocurrency market is understandable.
Even though the U.S. stock market is rising rapidly, the Standard & Poor's 500 index's 20-plus percent gain in 2017 pales in comparison to how the major cryptocurrencies performed last year. Bitcoin, for instance, now sells for roughly $15,000 -- some 15 times its year-ago value. Litecoin is worth nearly 60 times its year-ago value, and ethereum's "ether" has had a similar run-up.
Yet these currencies have also suffered dizzying drops. One day last November, bitcoin's value dropped 20 percent in less than two hours, and its value remains some 30 percent below the November highs. Some say this rise is proof of a "bubble," and its pop is certain to decimate investors.
However, bubble or no, investors have a wide array of reasons to be skeptical about investing in bitcoin and other cryptocurrencies. Specifically:
Hacking
Although the people who "mine" and "bank" cryptocurrencies maintain they have nearly unbreakable security, in numerous instances their vaults have been breached. Indeed, Fortune magazine maintains that cryptocurrencies are far more likely to be stolen than real currency. Hacking took down a South Korean bitcoin exchange, swiped $64 million from a Slovenian bitcoin "mine" and has caused some to question the viability of some of the more recent entrants into the cryptocurrency market.
Investors have learned the hard way that there is generally no recourse if your cryptocurrency disappears.
Fraud
When you buy euros or dollars, you can hold them in your hand -- inspect them, use a special light to make sure they're legitimate. Cryptocurrencies are traded in cyberspace, and few consumers are sophisticated enough to discern whether they're real or fake.
That's a nearly irresistible draw to crooks, who regulators fear are already nipping around the edges of the market, convincing gullible consumers to "invest" in nonexistent currencies. Indeed, the Texas State Securities Board on Thursday asked for an emergency cease-and-desist order against a British company called BitConnect, which is soliciting investors with promises of massive monthly returns. That's because it hasn't registered with state securities regulators, nor even provided an office address.
Regulators shut down a similar Dubai-based cryptocurrency operation in December.
Fickle faith
What makes most currencies valuable is investor faith in what backs them. The U.S. dollar, for instance, is backed by the full faith and credit of the U.S. government, which -- if all else fails -- has the ability to tax its citizens to pay its debts. Cryptocurrencies have no such government backing, and when they're deposited in "vaults," they're also not insured by the Federal Deposit Insurance Corp.
If investors suddenly lose faith in the ability of bitcoin's hierarchy to control the amount of currency issued or keep it safe, the value could drop to nothing overnight.
Limited usage
Generally speaking, you accumulate money to buy things. However, the number things you can buy with cryptocurrencies is severely limited. Bitcoin, the oldest and best-established of these currencies, brags that 100,000 merchants accept it as a form of payment.
But about 36 percent of those are other tech companies -- websites, hosting registrars and VPN services. If you pull those out, you have less than 70,000 merchants willing to accept bitcoin, worldwide. Finding one of those merchants isn't very hard, but it's not as easy as, say, finding a merchant that will accept your Visa card, which is good at roughly 29 million establishments. And can get you real cash at 2.3 million automated teller machines.
Government risk
Zacks Investment Research said the biggest risk for cryptocurrencies are governments themselves. Why? They could simply outlaw cryptocurrencies, and they might if the currencies ever become a threat to managing monetary policy.
To clarify, governments (normally through central banks) encourage -- or slow -- economic growth by managing their money supply. When the U.S. was in the depths of recession, the Federal Reserve pumped money into the financial markets to encourage spending, and thus, economic growth. Because cryptocurrencies circumvent this management, they could impair countries' ability to manage their economic health.
Crytocurrencies are currently a relative blip in the world currency markets, accounting for less than 1 percent of the world's cash. Thus, they have yet to create any significant risk to a major financial system. However, if they did, governments have the right to make the currency illegal and force users and investors underground.
Few governments have so far acted to restrict -- or outlaw -- cryptocurrencies, but they could. China, in fact, already has.
"If you choose to invest in these products, please ask questions and demand clear answers," Securities and Exchange Commissioner Jay Clayton recently urged investors.
Emphasizing that you could lose everything you put into cryptocurrencies, NASAA's Borg added that this market is "not for the faint of heart."