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Abu Dhabi, UAEWednesday 20 June 2018

Be warned: cryptocurrency investing will undoubtedly be hair-raising

Only thrill seekers should get involved, and they should still strap on a safety harness as this year’s perfect storm proves

An employee checks the fan on a mining machine at a cryptocurrency farming facility in Quebec, Canada. Investors in digital currencies should be prepared for a wild ride. Christinne Muschi/Bloomberg
An employee checks the fan on a mining machine at a cryptocurrency farming facility in Quebec, Canada. Investors in digital currencies should be prepared for a wild ride. Christinne Muschi/Bloomberg

You can say what you like about bitcoin and other cryptocurrencies but they are certainly never boring.

Last year they caught the imagination of the world by turning early investors into dollar millionaires or even billionaires, as the likes of bitcoin, Ethereum, Litecoin and Ripple rocketed.

Bitcoin opened 2017 trading at around $1,000 and peaked at just below $20,000 in mid-December, a rise of 1,900 per cent. Litecoin jumped a staggering 8,000 per cent, turning an investment of $10,000 into $800,000.

After the gain, the pain. So far 2018 has been a nightmare for investors in so-called “alt-coins”, especially those who arrived late at the party who may now be nursing hefty losses. At time of writing, bitcoin has slumped below $7,500, losing almost two thirds of its value.

By the time you read this, the price could be plunging below $5,000 or flying above $10,000 because cryptos are notoriously volatile, rising or falling by as much as 40 per cent in a single trading day.

Absolutely anything could happen. Last month, Saxo Bank analyst Kay Van-Petersen, who correctly predicted last year’s bitcoin rally, claimed it could rebound to between $50,000 and $100,000 this year, warming the hearts of worried investors.

Then in February Nobel prize-winning economist Nouriel Roubini labelled bitcoin the “mother of all bubbles” and predicted its value would collapse to zero. Mr Roubini was even more scathing of the estimated 1,300 initial coin offerings that have followed in its wake, calling them “a bubble to the power of two or three”.

If you want an authoritative view on the outlook for cryptocurrencies and whether you should invest in them, forget it, there is no such authority. Investors are in completely uncharted waters. How and where it ends is anybody’s guess.

Some might find that exciting, others will rightly find it terrifying. Only thrill seekers should get involved, and they should still strap on a safety harness.

So is the recent bloodbath the beginning of the end of the crypto currency frenzy, or just a temporary setback?

There will be blood

Bitcoin remains the world’s largest digital token with a total market capitalisation today of $132 billion, but that is far below its all-time high of around $326bn, which it hit on 16 December. What's that strange sound you hear? That’s crypto investors kicking themselves for failing to sell at the top of the market.

It is a similar story with all of the altcoins, none of which are immune to meltdown, which have bobbing down with the tide of news flow and investor sentiment.

A quick glance at the price chart for Ripple, which briefly looked set to usurp bitcoin as the dominant cryptocurrency, shows what a roller coaster investors have been on in recent weeks.

On December 11, it was trading at $0.25 before spiking to $3.65 on 4 January in a speculative frenzy. That would have turned $10,000 into $146,000 but only if you sold at the peak, and few ever manage that. If you hung on, you would have around $30,000 at today’s $0.75.

Vijay Valecha, chief market analyst at Century Financial Brokers in Dubai, says the correction has been driven by a regulatory blitz from fearful authorities all over the world. "Governments and regulators are unnerved by this decentralisation, and are taking precautions.”

Bitcoin has always had a dark side, first springing to public attention after drug dealers and weapons dealers exploited its faceless nature to fund transactions on the so-called dark Web.

In January, South Korea banned anonymous trading to counter money-laundering and calm the speculative mania that had gripped the country, which saw schoolchildren trading on their phones. Regulators even talked of shutting down domestic virtual currency exchanges.

China, another key market, also moved to assert control and curb capital outflows, by banning initial coin offerings, blocking domestic exchanges, and outlining proposals to discourage energy-intensive bitcoin mining.

India’s minister of finance Arun Jaitley joined the assault by saying his country does not recognise bitcoin as legal tender and calling it a Ponzi scheme.

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Bitcoin continues to plummet along with other cryptocurrencies

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Social network Facebook has now blocked initial coin offering adverts which it said are “frequently associated with misleading or deceptive promotional practices”, major credit card issuers are declining credit card transactions with known crypto exchanges in a bid to stop customers investing on credit. JP Morgan, Bank of America and Citigroup in the US, and Lloyds Banking Group in the UK, are all tightening rules.

This is starting to look like a concerted clampdown, as the authorities fight back against the freewheeling ethos of the crypto renegades.

Mr Valecha believes that rather than trying to destroy the sector, regulators want to bring it under their control. “The question now is how well they can bring a speculative asset class into the mainstream,” he says.

Cryptocurrencies also face technical problems, notably bitcoin, which is actually a rather unsuccessful currency, as transactions are slow and expensive, and its rampant volatility means neither buyer nor seller has any idea what it will be worth once the transaction completes.

Some say its future could be as a store of value, such as gold, but even here volatility is a problem, Mr Valecha says. “Gold has an average daily volatility of 1.06 per cent, bitcoin has a daily volatility of 6.07 per cent.”

He predicts more swings but remains optimistic that current teething troubles will pass. “In the long term, cryptocurrencies still hold up to the bullish view point.”

Another concern is that bitcoin is not particularly secure, as people risk losing their money if they lose their digital passwords or their online wallet is targeted by hackers. An estimated than three million bitcoins have been lost, maybe forever, a large chunk of the total 16.85 million currently in circulation.

Hackers stole more than $500 million in cryptocurrencies from the Japanese exchange Coincheck last month, although the site has said it will reimburse victims.

Holding on

Cryptocurrency enthusiasts have been knocked down by this year’s perfect storm, but they are not yet out.

Long-time altcoin enthusiast David Mondrus, chief executive of the blockchain-based research platform Trive, has dismissed current problems as early-year market blues. "In 12 months we won’t even remember it,” he says.

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Read more:

UAE issues warning against initial coin offerings as cryptocurrencies plunge

Bitcoin slides as Facebook ad ban, India clampdown unnerve investors

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Bitcoin has endured plenty of similar falls in the past, many of them coming in a January. One theory blames the timing of the Chinese lunar new year, as locals cash in their coins to fund travel and gifts in advance of February 16. So, cross your fingers, the second half of February may be brighter.

Fawad Razaqzada, a market analyst at Forex.com, says as sentiment sours many people are having second thoughts about investing their hard-earned cash in digital currencies, but that could change. “Would-be buyers are probably waiting on the sidelines until the downtrend is over, while existing buyers may be selling up to protect their remaining profit.”

Sentiment could reverse once there is clear evidence that prices have bottomed out, he adds. “A lot of people still want to get on board when the time is right. Things are not looking great for bitcoin right now, but that could change due to pent-up demand.”

Today might even be the buying opportunities crypto enthusiasts have been waiting for. Brave investors who were kicking themselves for failing to buy bitcoin last time it traded below $8,000, in November last year, have been granted another chance.

However, they would be taking a huge gamble - and with real money. Bitcoin could fall another 60 per cent, or 100 per cent.

Tuan Phan, a board member of Common Sense Personal Finance and Investing, a non-profit community of UAE investment enthusiasts, says an old investment rule continues to apply to this new asset class: “Don’t invest in anything you do not fully understand. Unless you have a clear understanding of blockchain technology, the concept behind bitcoin and a clear strategy how to enter and exit this volatile market, your get-rich-quick dream may turn into a nightmare.”

Since few people do understand the blockchain concept, this rules out most ordinary investors.

Mr Phan says existing bitcoin holders face tricky choices but need to develop a clear strategy. “They should consider using a stop-loss to protect themselves from another huge market drop.”

New investors should decide on a clear price floor, at which point they can start buying again, and a ceiling at which to lock in any profits. “This way they may potentially be able to take advantage of bitcoin’s extreme volatility,” says Mr Phan.

Another old investment mantra applies: do not put all your eggs in one basket. “Investors should consider diversifying into other coin offerings as well as traditional assets such as stocks, bonds and cash,” he says.

Finally, only invest money you can afford to lose, because you could lose the lot.

Like many experts, Mr Phan says it is important to draw a distinction between cryptocurrencies and the underlying blockchain technology. “This may be the beginning of the end for bitcoin but only the beginning of blockchain technology, which looks set to transform financial transactions.”

Bitcoin shares many similarities to the dot.com boom and bust either side of the millennium, he adds. “From the ashes rose companies such as Google, Apple and Amazon that have changed the world.”

That will be little consolation if you have lost all of your money along the way.

Lee Wild, head of equity strategy at website Interactive Invester, says investors are now nervously second-guessing what the authorities will do next. “The regulatory clampdown risks bringing the crypto party to a bloody end, but there’s no guarantee the South Korean and Chinese governments will follow through on threats to ban the practice.”

Jordan Hiscott, chief trader at Ayondo Markets, says the blockchain's underlying value has been distorted by speculative frenzy. “If bitcoin is to achieve longevity, the crypto community needs to decide whether it is a hyper-turbo speculation tool or a genuine form of digitally secure monetary transactions. In my view, it can’t be both.”

Mr Hiscott does favour one crypto in particular, Ripple’s XRP, which is designed to help banks and money-transfer services send funds across borders quickly and at low cost. “Ripple has the potential to take cryptocurrencies to the next level. It is being used by a growing number of major financial institutions, so has some credibility," he says.

"In addition, there is a genuinely structured company behind it, while its cryptography puts it above the rest.”

Ripple may transform global payments, but that does not mean it will necessarily make you spectacularly rich. The glory days may now be over for good. Although people have said that before.