Cryptocurrency: understanding the risks.

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Cryptocurrencies are rapidly gaining popularity amongst investors due to being advertised as ‘get rich quick’ investments. They have particularly increased in attractiveness since the pandemic, with many people feeling obliged to take on greater risks to compensate for the economic uncertainty and concerns caused by the rising cost of living. However, cryptocurrencies are extremely speculative, risky and unregulated.

Jonathan Watts-Lay, Director, WEALTH at work, a leading financial wellbeing and retirement specialist, explains cryptocurrencies and highlights the main risks to be aware of:

What are cryptocurrencies?

A cryptocurrency is a digital or virtual currency that is secured by cryptography (encrypted data). Cryptocurrency does not exist in physical form (like paper money) and is typically not issued by a central authority, rendering them supposedly immune to government interference or manipulation.

Why are they attractive to consumers?

There are some factors that make cryptocurrencies attractive to consumers such as cheaper and faster money transfers and the fact that they enable secure online payments without the use of third-party intermediaries. They are also decentralised so they cannot be influenced by governmental/economical events that currencies issued by a central authority would be impacted by.

What are the risks?

The high price volatility of cryptocurrencies is the major risk.  It makes them poorly suited to the three traditional uses of a currency: as a store of value, as a unit of account and as a medium of exchange.  In fact, apart from occasional publicity stunts, it is hard to see why any normal business would be willing to be paid in a cryptocurrency.

What are the ethical concerns?

Cryptocurrencies have significant drawbacks from an environmental perspective due to the high energy consumption involved in mining activities.  For example, Bitcoin’s annual electricity use is nearly equal to Sweden’s.  Power consumption is one of the reasons for China’s recently introduced restrictions on cryptocurrency mining, which have at least temporarily led to a significant decline in global bitcoin mining.

The Financial Conduct Authority (FCA) have also recently announced that there is a major link to money laundering and serious organised crime being propagated through crypto exchanges.

Is there any regulation and protection?

Cryptocurrencies are not regulated in the UK, meaning people are not protected by consumer protection laws if their funds are lost for any reason.

The FCA announced that around 90% of applications from crypto exchanges in the UK are either ‘withdrawn or refused’ and argue that some crypto assets have ‘no intrinsic value’ at all.

What are Cryptocurrency frauds and scams?

Cryptocurrencies have opened up a new pathway for investment scams to grow.

Data from Action Fraud, the national reporting centre for fraud and cybercrime, revealed in late 2021 that a shocking £146m had been lost to cryptocurrency fraud since the start of the year – which is almost a third more than was lost throughout the whole of 2020.

Jonathan Watts-Lay, Director, WEALTH at work, comments; “The popularity of cryptocurrencies has mainly been driven by stories of crypto millionaires and a natural investor behaviour, the fear of missing out. However, they are highly speculative assets, with high volatility, unreliable correlations and a significant risk of their values eventually falling to zero.”

He explains; “It’s important investors consider and understand the risks involved with cryptocurrency investments, as well as the dangers of other high risk investments. It is always important to remember that if something sounds too good to be true, it probably is.”

Watts-Lay adds; “There are many types of investments available that can help you achieve your financial goals. Each investment type — from bank products to stocks and bonds — has its own set of features and risk factors to be aware of. Most people aren’t investment experts, so may need help understanding their options. Many workplaces offer their staff financial education to help them understand their savings and investment options, so it’s always worth speaking to them to see what’s available. Also, a financial adviser can work with you to agree what level of risk you can afford to take, balanced with the returns you want to achieve in the context of your overall finances.”