Cryptocurrencies: what are they and what are the dangers of investing in them?

Cryptocurrencies: what are they and what are the dangers of investing in them?

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06.May.2022

If you had invested 1,000 euros in bitcoin 10 years ago, today you would have 9.6 million euros in your account after adding a profit of 966.768%. That figure sums up the appeal of cryptocurrencies and the crypto ecosystem to the average Joe.

The profit potential is so high and there are so many stories in the media about people who have become millionaires with cryptocurrencies and derivatives like NFTs (tokenized digital artwork, among other things) that it quickly sets off all the alarms in our brains. Am I letting a golden opportunity slip by? If everyone else is making money with cryptocurrencies, why shouldn’t I?

The reality is that investing in cryptocurrencies is not that simple and of course it is not that safe either. In fact, the first thing to do is to understand what they are.

What are cryptocurrencies and blockchain

“Never invest in businesses that you can’t understand”, warns Warren Buffett and the truth is that most cryptocurrency investors are not clear about what they are and where their value lies.

What exactly is a cryptocurrency? These are digital currencies that use cryptographic methods to secure the transaction through blockchain technology.

As currencies or digital money, these are decentralized assets. In other words, they do not depend on a central bank or any country to control their issuance or validate them. The users who hold the currency are the ones in charge of doing this, through blockchain technology.

In fact, the true potential of cryptocurrencies and the entire crypto world lies precisely in that technology, which is what expands their use beyond that of becoming a commonly used currency or coin. And only a few cryptocurrency projects actually aspire to be used in this way.

The following video explains how this blockchain works and what its potential is: What is “Blockchain” in 5 minutes.

So, when you buy a cryptocurrency, what you are actually doing is investing in a specific crypto project with a specific purpose (and you should analyze this to make your decision about whether to invest or not). If you are not sure about that, maybe cryptocurrencies are not for you or, in any case, you should focus on Bitcoin, the first cryptocurrency to be created and the one that drives the value of the rest of the tokens or altcoins (alternative cryptocurrencies created after Bitcoin).

Why are they in fashion? Are they the future?

Cryptocurrencies emerged as a non-centralized payment alternative, not controlled by a central bank and non-manipulable. They arose in response to the loss of value of traditional money with the disappearance of the gold standard and the possibility of governments printing more money to finance their expenses and, as a result, devaluing the money in circulation.

This decentralized and more democratic alternative, in which neither the State nor traditional banks act as intermediaries, is one of the initial attractions of bitcoin. On the one hand, it provides greater anonymity (although the blockchain is public) and on the other it is more democratic, since the validation power lies with the users and not with a third party (bank or state).

However, the reality is that what has skyrocketed Bitcoin and other cryptocurrencies has more to do with the speculative revaluation of assets and the cover they have had in traditional and social media. In other words, news like that 966.768% gain or a 1,000 euro profit in just a few days that can be achieved with NFT and certain cryptocurrencies.

In the end, these are attractive stories about a technology with an enormous potential to change the world (although few crypto investors really understand that), which can make you rich quickly and easily. And that surely sounds more like lifelong financial speculation, which is what drives most small investors to invest in Bitcoin and other cryptocurrencies.

Is it advisable to invest in cryptocurrencies?

Cryptocurrencies are just another investment asset, like private shares, investment funds or buying a house to rent out. The key to making your decision depends on your objectives and your investment profile.

What is recommended is that you understand the risks of investing in cryptocurrencies:

  • They are not backed by anything except for their community and the idea they represent. They are completely unregulated.
  • Tomorrow a bitcoin could be worth nothing (or much less than now), which is what often happens when a financial bubble bursts and what happened with the tulip bubble in the 17th century (in fact, some people have been comparing the evolution of bitcoin to this crisis for years).
  • It is very volatile. The price of bitcoin rises and falls by an average of 6.5% every day. In other words, the value of your investment will behave like a roller coaster. Are you ready for this?
  •  There is way, way too much on offer. There are more than 8,000 cryptocurrencies to choose from and guessing which one will succeed next is very complicated, especially if you don’t understand the value of each project.
  • The security of your cryptocurrencies is complex. Cryptocurrencies have a private security key that certifies their authenticity. If you lose this, you will lose your cryptocurrencies, they will vanish (and you would not be the first person that happens to).

From this point, it’s a matter of you evaluating how bitcoin fits into your investment portfolio and your financial plan. If you are a long-term investor, in most cases there are more suitable formulas for achieving your goals.

Of course, some people also invest in cryptocurrencies for the long term, but they do so outside the speculation inherent in cryptocurrencies, with a buy-and-hold strategy and a conviction (and understanding) that they are the future. In other words, they invest like successful (long-term) investors, only they also include Bitcoin in their plans.

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