Bitcoin Risks: An Overview

2018-03-29

The headlines about Bitcoin have been impossible to ignore. With so many conflicting perspectives circulating in the media, an informed evaluation of Bitcoin’s investment worthiness is difficult for most to achieve.  As tempting as its meteoric rise looks, most financial professionals tend to stay away from products that regularly experience disturbingly huge drops.  Bitcoin’s volatility is certainly a deterrent, but here are a few risks that further explain why our long-term investment strategies exclude this particular cryptocurrency:

Recognizing risk vs hype

Less than one third of Bitcoin are in actual circulation – the rest have been purchased for speculation.  From a purely numeric perspective, the value of Bitcoin has plummeted over 30% multiple times in the last year.  This alone is enough to raise concern about the long-term valuation and stability of this type of investment. On the technical side of things, the blockchain created for Bitcoin has already been challenged by another blockchain technology, Etherum – now the second largest cryptocurrency network.  Etherum has created a fork of blockchain cash in order to reduce transaction times and improve efficiencies.  The full effect of this on Bitcoin remains to be seen.

Use and trading

At present, Bitcoin is not widely accepted by businesses here in North America.  Since purchasing power hugely defines a currency’s value, it remains an illiquid asset; and the currency’s volatility renders consistent merchant product pricing virtually impossible.  The CME recently accepted derivative on Bitcoin, with futures first opened on December 18, 2017 (you can read more on that here).  On a global scale, both China and South Korea are against crypto exchanges.  Again, we have yet to see the full impact of this stance, but their markets have considerable influence and cannot be ignored.

Security risks, investor emotions and the bottom line

While blockchains claim to be virtually “unhackable”, we have already seen evidence that this is not the case. Cyber-attacks have hit Bitfinex, the world’s largest cryptocurrency trading platform, and later Mt Gox, which is no longer active. The latter was once hacked for 850,000 Bitcoins – approximately $7 billion by today’s rates – and then saw a 70% drop in value due to a lack of consumer confidence. When a cyber-attack hits – and it does happen – the results are often devastating.  Furthermore, a serious and unpredictable risk to Bitcoin is investor emotion. Cryptocurrency is controlled by individual investors – not an institution. Subsequently, volatility can occur as a result of investor emotions (a recipe for trouble, in our view).  Finally, we have concerns about Bitcoin’s margins. In addition to derivatives, Bitcoin investors must deal with huge fluctuations, margin calls, shorting and long Bitcoin trades.  When we think of your wealth and security, these are not risks we are willing to take.

As we explained in a recent blog post on long term Meta trends, we are highly attuned towards the inclusion of future opportunities in current investment decisions.  So while we agree that cryptocurrencies are here to stay, we also agree these will likely become a component of future investment models, but: we need to wait for the cryptocurrency landscape to stabilize.  Because it’s our job to ensure we don’t put our clients on a speeding train with an unknown destination and before the final tracks are laid, it is still too soon to include Bitcoin – or any cryptocurrency – in a professional long-term wealth strategy.

For more information about the technology, please see our Blockchain post here.


SOURCES:
https://www.reuters.com/article/uk-global-bitcoin/bitcoin-falls-30-percent-posts-worst-week-since-2013-idUSKBN1EG0A8
http://money.cnn.com/2018/01/17/investing/bitcoin-price-drop/index.html
https://www.reuters.com/article/us-japan-bitcoin-mt-gox/chief-of-bitcoin-exchange-mt-gox-denies-embezzlement-as-trial-opens-idUSKBN19W07Z