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How dangerous is a Bitcoin investment really?

by | 24 Jun 2021

We as a fintech company, who are very closely linked to the crypto market, see this market almost exclusively in a good light.

Nevertheless, one should always look at situations as objectively and holistically as possible. Therefore, we will now take a look at the risks that can occur when investing in the largest cryptocurrency, Bitcoin.

Volatility

Bitcoin has historically averaged a return of 210% per year since its inception in 2009, which is incredibly good. However, this return has not come about nice and consistently year after year, but rather in large upswings and associated with sharp corrections. A good asset manager is not only measured by the pure return, but above all by how much risk he has accepted for the return, or how much his positions were in negative territory in the meantime. In the case of Bitcoin, this can easily be -60 to -80%, which is risky depending on the entry point.

Liquidity

Bitcoin’s total market capitalization is still tiny compared to other asset classes (although rising rapidly). Therefore, there are real costs associated with putting capital into Bitcoin. What is meant is that when buying, you have to be careful that your investment does not drive up the price of the cryptocurrency. However, recent high-profile Bitcoin investments by MicroStrategy, Square, and others show that it is slowly becoming possible to allocate on a larger scale.

Transaction costs

The cost of buying and selling on an exchange is far too high compared to other asset classes. This fact eats away some of the performance achieved and makes active trading difficult. It can be expected that the costs will converge with the other asset classes over time.

Operational risks

Key question: where does one keep the precious Bitcoin safe?

One can use a private wallet (hard or software), which is not technically straightforward. The responsibility and risk of loss is now in one’s own hands. Custody solutions allow the risk of keeping the private key to be transferred from one’s own person to the custodian organization, which must then be trusted. The risk is thereby transferred, but not reduced.

One can also leave Bitcoin on the exchange, these have developed well in recent years; however, there is still the hacker risk. There is currently still a lack of both secure and simple solution to give Bitcoin even more credibility.

Transaction Risk

One of the greatest strengths of Bitcoin, the ability to transfer value independently of any third party, around the clock and in any volume at minimum cost, comes with risks.

Transactions are irreversible, sending to a wrong address currently still leads to total loss, which is quite daunting. Solutions are needed to reverse erroneously sent transactions or to prevent this from happening in the first place.

Regulation

Bitcoin was ridiculed by governments for years and not taken seriously. Now with increasing size, user base and market capitalization, Bitcoin should be on every government’s radar. At the latest, when recently the Central American country El Salvador put Bitcoin on the same level as the US dollar. This is unlikely to please the U.S. in particular. Bitcoin is likely to become more and more a thorn in the side of the world’s national banks, which like to have sole control when it comes to the monetary system. This threatens stricter and stronger regulation with an uncertain outcome.

51% attack or coding error

Because the Bitcoin system is digital, autonomous, and distributed across thousands of computers worldwide, there is a risk that bad actors (hackers) may want to attack the network to gain a majority and then manipulate it. A sudden error in the code is another risk factor, which would probably have a significant negative impact on the price.

Market manipulation

Currently, a Twitter post by the world-renowned entrepreneur Elon Musk (Tesla) is enough to control the Bitcoin price to his liking. This indicates a lack of market size, as well as low confidence in investors’ own position. This is an additional external and hardly calculable risk regarding a Bitcoin investment.

Further, there may be currently unknown risks, as the global covid pandemic can serve as an example. Being aware of all these factors can help to make decisions and be optimally prepared; both mentally and technically.

Stay tuned!