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Cryptocurrencies as an asset class acquired during the pandemic. The two most popular cryptocurrencies (by trading volume and also by market capitalization) are Bitcoin and Ethereum. Since January, Bitcoin has risen by around 141%, while Ethereum has increased by over 250%. Both are at their three-year highs.
Cryptocurrencies are speculative reserves of value. Coins are unique codes, not fiat currencies guaranteed by central banks. A coin can be divided into fractions, each fraction defined by its unique code. Each cryptographic transaction is verified by a blockchain matching peer process, to see if a particular coin is valid, if it is contained in a particular wallet (the owner of the wallet can be anonymous), and a particular coin is not used in two transactions at the same time.
If a password is cracked, there is no remedy. Therefore cryptocurrency trading carries a high “digital” risk. Bitcoin also has a bad reputation for being the currency of choice for cybercriminals. An advantage for everyone: if you store the codes, without any electronic or physical registration, and continue to trade cryptocurrencies.
Cryptocurrencies are not used very often in ordinary transactions. However, they are very useful for cross-border transactions. They allow for convenient currency exchange, bypassing controls and minimizing transaction costs. Buying Bitcoin in rupees and selling it in US dollars is an efficient way to exchange rupees for dollars, compared to a standard INR-USD exchange, with bank fees.
Some nations, including large economies like Japan and Korea, allow the use of cryptocurrencies in business transactions. Some prohibit them. In many countries, cryptocurrencies are a legal gray area or are treated as objects of art and curiosities. Like art, cryptocurrencies may have little intrinsic value but can be very expensive depending on demand.
The RBI imposed a cryptocurrency ban, which was lifted by a Supreme Court decree in March 2020. Indians can trade cryptocurrencies on different exchanges, in rupees. It is perfectly possible that cryptocurrency trading will be banned again, perhaps through legislative action. This is a risk you need to be prepared for if you trade cryptocurrencies.
Aside from regulatory and digital risks, prices are very volatile. The daily price ranges for cryptocurrencies are higher than those for stocks, derivatives and forex. This is because there are no fundamental factors influencing the price. So, prices are driven solely by supply and demand and those variables are driven solely by news sentiment.
Since 2015, Bitcoin has a daily high-low range of more than 5% (as a percentage of the daily average price). There is also friction in cryptocurrency trading. Arbitrage between exchanges is common due to the significant price difference. Commercial confirmations are slow. Verifying the blockchain takes time, especially on high-volume days.
Given all the risks, why trade cryptocurrencies? The potential returns are high. Cryptos have been big gains in troubled times. In this sense, cryptocurrencies are like gold; paradises during uncertainty.
Indeed, the concept of Bitcoin was triggered by the 2008 subprime crisis and saw strong rallies in the 2011-12 global financial crisis. Earn money whenever there is geopolitical tension or financial turmoil. Cryptocurrency trading volumes out of India increased during demonetization, for example.
Will global uncertainty continue in 2021?
Yes. There is good news about vaccines. But it will take a long time before 7 billion are immunized. The global economy is a disaster. Geopolitics is also a disaster. Think about Brexit, the difficult transition of power in the US, the continuation of the civil war in Syria, Ukraine against Russia, Poland and Hungary against the EU, India-China, etc.
It will take at least two years, or more, before the global economy is in reasonable condition. Cryptos should continue to be net gains, although there are sure to be huge corrections in between. If you’re comfortable buying art as an investment, cryptocurrencies can deliver more returns, for a similar level of risk.
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