Even though buying cryptocurrencies seems like a lucrative alternative investment, don’t forget they are extremely risky as they are not backed by any underlying asset
On the positive side, there is some evidence that favours crypto investments.
By Moinak Maiti and Parthajit Kayal
It’s been more than a decade since the first cryptocurrency, Bitcoin, was launched in 2009. Since then, the cryptocurrency market’s popularity has been growing as it has generated quick wealth for many investors despite the high risks associated with it. Today there are thousands of different cryptocurrencies out there for investment. Popular examples are Bitcoin, Ethereum, Dogecoin, XRP, Ripple, etc.
Characteristics of cryptocurrencies
So, what exactly is a cryptocurrency? To understand it, let us break the term ‘cryptocurrency’ into two: “crypto” and “currency”. The word “crypto” here refers to hidden information. The hidden information includes the details of the owners and payments details that are made secure by using advanced technology. The word “currency” here refers to digital cash. The characteristics of the cryptocurrencies are not like cash or paper currencies that are used for regular transactions. The behaviour of cryptocurrencies is also not similar to other financial assets that are traded in the financial market. That is why central banks usually refer to cryptocurrency as “cryptoassets”.
In general, cryptocurrencies are not backed by any assets except the “asset-backed Stablecoins” such as Tether. Cryptocurrencies do not have balance sheets unlike financial assets, nor are issued by any central banks,or backed by any government. All of these characteristics make cryptocurrency a very risky investment. Cryptocurrencies are highly volatile and the behaviour of cryptocurrencies is complex and different. Certainly, investment in cryptocurrencies requires different skill-sets.
What drives cryptocurrency prices?
Before investing in cryptocurrency it is important to understand what drives cryptocurrency prices. Definitely, the value of anything is determined by the demand and supply. Here cryptocurrency is not an exception. Other factors that drive cryptocurrency prices mostly are the cost of mining, competition (competing cryptocurrencies), regulatory changes, media coverage/social content, and personage remarks.
Recently, we saw how celebrity remarks about a cryptocurrency significantly drives the respective cryptocurrency’s price. Elon Musk on October 31, 2021 tweeted that “Tuition is in Dogecoin & u get a discount if u have a dog”. After Musk’s tweet, Dogecoin recorded a jump in the price immediately.
Another typical example could be the cryptocurrency inspired by the drama series ‘Squid Game’ on Netflix. The Squid Game cryptocurrency was made available for purchase on October 20, 2021, letting the investors buy a pay-to-play token for an online game called ‘Squid Game’. The Squid Game cryptocurrency has touched the impressive peak price value of $2,861.80 since its launch on November 1, 2021. Subsequently, on the next day, it was traded at a value approximately close to zero.
Thus, just within a period of two weeks since its launch, Squid Game turned out to be of zero value, making it worthless. Experts say the peak price value of Squid Game cryptocurrency could be attributed to the wide mainstream media coverage. Before investors could react to this situation, the creator of the Squid Game cryptocurrency pulled off the currency from the crypto exchange draining all the liquidity. Investors made a huge loss due to the “rug pull”.
On the positive side, there is some evidence that favours crypto investments. El Salvador is the only country that has officially adopted bitcoin as legal tender. Then Wharton announced that it will accept tuition fees in cryptocurrencies including Bitcoin, Ethereum and USD Coin for its upcoming executive programme on “Economics of Blockchain and Digital Assets”.
Cryptocurrency investment in India
In recent times, investment in cryptocurrencies is gaining significant popularity among Indians due to steady innovations in the digital landscape and wide advertisements of cryptocurrency investment across media platforms. Further, the post-Covid stellar performance of the equity market has attracted a new generation of risk-tolerant investors who are even willing to bet on the crypto market. India now has around 15 homegrown cryptocurrency exchange platforms with almost two crore users.
Even though the cryptocurrencies investment seems like a lucrative alternative investment, never overlook that they are extremely risky. Moreover, they are not backed by any underlying asset. Thus, crypto investors must carefully evaluate the choices for the crypto exchange and cryptocurrency when making investment decisions. They should only invest a small amount of their savings into these kinds of investments.
Maiti is associate professor, National Research University Higher School of Economics and Kayal is assistant professor, Madras School of Economics
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