One in five Australians already own some form of cryptocurrency1, and that is set to double in coming years2.
Bitcoin is in its 14th year which in and of itself ought to at least challenge the notion that cryptocurrencies are a fad. Furthermore, crypto-asset users globally are now estimated to number 221 million spanning a $3 trillion market3. It’s an asset class financial advisers now need to understand, even if they never recommend it.
Crypto currencies tend to polarise investors. But the asset class is ever changing and so not only is it an oversimplification to paint all crypto projects with the same brush, a firmly held position on any particular project needs to continually be re-examined. For example, Bitcoin has evolved to address some of its earlier shortcomings and new crypto projects have a habit of addressing the shortcomings of earlier crypto projects while also applying the underlying technology in different ways.
In essence, cryptos are a form of record keeping which is maintained by a network of smaller (decentralised) nodes rather than a large and singular (centralised) organisation. Where finance is concerned, cryptocurrency performs functions that many mainstream financial institutions perform, such as payments. Sometimes cryptos do it quicker, cheaper and can cut out the intermediaries. And sometimes they aren’t quite there yet, although that is their aspiration.
For an investor, the critical question is how to value a crypto currency? Supporters tend to value cryptos in terms of the total addressable market, using rules-of-thumb, to say the asset class should be valued as a proportion of all assets. Sceptics point to the fact that unlike fiat money, crypto has no sovereign backing, and it isn’t real – there’s no tangible currency.
The bottom line is that there’s no consensus yet on how to value crypto-currencies, and it will take many years before that’s achieved, if ever.
There are a number of concepts, popular (mis)conceptions and features of crypto currencies investors should be aware of.
Staking is a way of earning an income from crypto ownership. At its most basic level, staking involves the crypto owner lending their cryptocurrency. Most of the time the crypto is lent back to the network as a source of liquidity. On occasion, staked funds will be lent out for some other purpose, like peer-to-peer lending, so investors need to be aware of how their staked funds are being used.
By and large, crypto investors who engage in staking will do so through a crypto exchange provider who pools together smaller quantities of staked coins.
The amount of income a staking investor earns is determined by the staking reward or APY, which stands for annualised percentage yield. Although APY’s do vary, some cryptocurrency exchanges currently indicate a return of 10 to 20 per cent is possible through staking4.
One of the pitfalls of the crypto world is its lack of transparency and consumer protection. While each scam has its own quirks, investors should be on the lookout for some warning signs. For example:
- The timing and/or naming of the coin is opportunistic – the Squid Game crypto came on the heels of the hit Netflix tv series. It initially soared and then fell to be almost worthless.
- The price has risen sharply for no apparent reason.
- Celebrity endorsement should be considered a warning sign.
- The creators of the crypto project are either anonymous or unknown to industry players.
- The APY seems too good to be true.
- The purported use case doesn’t make any sense.
Bitcoin consumes a substantial amount of energy, but it could be wrong to assert that cryptocurrency is (or will be) bad for the environment.
Cryptos will evolve and that means issues like security, scalability, and energy efficiency can be improved or resolved. It’s exactly what’s happened in paper currencies.
Ethereum, for example, is undergoing a modification that will see its carbon footprint, according to some reports, fall by as much as 99.95 per cent5. New cryptos are being developed with low carbon emissions in mind.
Investing in cryptos
Like every asset class, an investor must be comfortable with the risk involved in putting money into crypto currencies. According to e-cryptonews.com over 2,000 cryptocurrencies have failed in the last 10 years out of approximately 10,000 in existence6.
Normal investment rules apply. Investors should consider their overall financial position and goals before investing in crypto, and the amount of money going into the asset class is a critical decision for would-be investors. Diversification within the crypto sector is another important consideration.
Active investing in cryptos should be done with eyes wide open. The best thing a typical investor can do is to devise a simple, diversified, long-term investment plan – and stick to it. And that might not involve cryptos.
For more information on this topic, please view our whitepaper, Crypto: more than a speculative mania?
Subscribe below to SMSF News to receive my latest articlesBrad Creighton, Portfolio Manager
While every care has been taken in the preparation of this article, AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232497) and AMP Capital Funds Management Limited (ABN 15 159 557 721, AFSL 426455) (AMP Capital) makes no representations or warranties as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. Past performance is not a reliable indicator of future performance. This article has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. An investor should, before making any investment decisions, consider the appropriateness of the information in this article, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. This article is solely for the use of the party to whom it is provided and must not be provided to any other person or entity without the express written consent of AMP Capital.
This article is not intended for distribution or use in any jurisdiction where it would be contrary to applicable laws, regulations or directives and does not constitute a recommendation, offer, solicitation or invitation to invest.