Five things you need to know before investing in cryptocurrencies

Cryptocurrencies are virtual assets, payment systems, and in a few rare cases, legal tender too. They are ever-evolving with new use cases being invented regularly. They are decentralised and thus not controlled by any authority or regulated by any government entity. Cryptocurrencies form one of the most volatile asset classes, and several aspects of it are steeped in obfuscation. In India, the interest in crypto touched new highs this year with many start-ups and crypto exchanges foraying into the space.
 
One can buy digital currencies through specific crypto exchanges in India as traditional brokerages have not started this facility yet due to a lack of regulations. You can register with these exchanges, complete your KYC, and start trading tokens.
 
There are over 10,000 cryptocurrencies currently available across the world. Some of the best known digital currencies are Bitcoin, Litecoin, Ethereum, Cardano, Dogecoin, Tron and Ripple among several others. Bitcoin is the first and largest virtual coin that controls over 40% of the total market value of all cryptocurrencies put together.
 
Given the massive exponential rally in their prices over the last few years, youngsters in particular are attracted to this new investment avenue. However, many just come anticipating big returns in quick time without knowing how the cryptocurrencies work and what the risks are.
 
Here are the five things you should know before putting your money in cryptocurrencies.
 
Cryptocurrencies Are Decentralised And Unregulated
 
Cryptocurrencies are decentralised networks based on blockchain technology. Blockchain is an organisational method that ensures the integrity of transactional data. It essentially means that ‘crypto’ is a form of a digital asset that is based on a network distributed across a large number of computers around the world. Because of their decentralised nature, they are out of the control of governments and any other authorities.

Currently, several governments and central banks are discussing how to regulate cryptocurrencies while allowing them to exist for trade, investment, or technological innovation. It is worth noting that only a few countries have banned cryptocurrencies signifying that the world is fast realising that cryptocurrencies may be the new normal that needs we must adjust to. There are many cryptocurrencies available in the market. Before investing in them, it would be wise to do thorough research and understand the risks involved. 
 
Excessive Volatility 

The prices of cryptocurrencies are extremely volatile. They are traded 24×7 around the world, often by anonymous investors who can manipulate the market due to the absence of regulation. There’s lack of information on what drives prices either way. Often, the whiff of regulatory action in any country can drive prices down. Similarly, speculation can drive prices up. Crypto’s volatility dwarfs that of equity markets. A 10% crash in a stock index will shock the markets. But 10% movements are an almost daily occurrence on crypto exchanges.

For instance, Bitcoin – the first cryptocurrency and the largest now by value – has witnessed a roller-coaster ride in recent years. In mid-December of 2017, the price of a Bitcoin touched a high of $19,650 and got nearly halved in the very next month. As the Pandemic hit the world’s market in 2020, Bitcoin fell to $5,000 in March and rallied to over $61,000 by March 2021. Then it got halved by July to $31,000 before surging to $49,000 in the very next month and then jumped to $65,000 in November this year. Currently, it is trading below $50,000. If you are not comfortable with extreme volatility, stay away from cryptocurrencies. However, if you are still investing in crypto, limit your exposure and buy only quality coins.
 
Speculative In Nature

Since cryptocurrencies are still in an evolving stage, several financial experts believe that they will turn out to be short-lived fad. However, another section of financial experts opines that cryptocurrencies may disrupt the current financial system and bring altogether a new system of transaction. It’s likely that the majority of cryptocurrencies will not survive, and a handful of the best ones will. There is lack of clarity on various facts of cryptocurrencies, most importantly about their utility. Some treat it as currency, some use it for payments, others for participating in communities, and most as an investment whose price is being driven by speculation. Cryptocurrencies are not backed by an underlying asset. For example, a stock’s price is driven by its company’s performance. Cryptocurrency prices are driven only by speculation. Therefore, cryptocurrencies are in a prolonged bubble.
 
Exposed To Cyber Attacks

Though based on highly secure blockchain technology, cryptocurrencies can potentially be at risk from infosecurity threats. The different parts of its ecosystem like exchanges that allow you to trade cryptocurrencies, or digital wallets, may not be completely immune to cyber hackers. For instance, in the case of Bitcoin, many online exchanges were infiltrated with hacking and theft of coins worth millions of dollars.
 
Gains From Cryptocurrencies Are Taxed

There are no set guidelines for cryptocurrency taxation in India. Although these virtual online currencies are still unregulated, gains made from them are subject to capital gains tax as per the Income Tax Act in a way similar to gold. Your gains could be classified as short-term or long-term given the duration of your holding. The details are filled either in the business income or other income in your returns.
 
The Indian government is working on a financial bill to regulate virtual currencies, which may give clarity on how the crypto market will operate in the country going forward. Thus, prospective investors should take expert advice before investing in cryptocurrencies. It may be advisable to take a carefully calibrated exposure congruent with your wealth goals, risk tolerance, and returns expectations.

(The author is CEO, BANKBAZAAR)