It's possible to get filthy rich by investing in cryptocurrency in 2021. But you could also lose all of your money. How can both be true? Investing in crypto assets is risky but also potentially extremely profitable.
Cryptocurrency is a good investment if you want to gain direct exposure to the demand for digital currency, while a safer but potentially less lucrative alternative is to buy the stocks of companies with exposure to cryptocurrency.
Let's examine the pros and cons of investing in cryptocurrency.
Is cryptocurrency safe?
Several factors make cryptocurrency not entirely safe, at least currently, while other signs are emerging that cryptocurrency is here to stay.
Cryptocurrency exchanges, more so than stock exchanges, are vulnerable to being hacked and becoming targets of other criminal activity. These security breaches have led to sizable losses for investors who have had their digital currencies stolen.
Safely storing cryptocurrencies is also more difficult than owning stocks or bonds. Cryptocurrency exchanges such as Coinbase (NASDAQ:COIN) make it fairly easy to buy and sell crypto assets such as Bitcoin (CRYPTO:BTC) and Ethereum (CRYPTO:ETH), but many people don't like to keep their digital assets on exchanges due to the aforementioned risk of cyberattacks and theft.
Some cryptocurrency owners prefer offline "cold storage" options such as hardware or paper wallets, but cold storage comes with its own set of challenges. The biggest is the risk of losing your private key, without which it is impossible to access your cryptocurrency.
There's also no guarantee that a crypto project you invest in will succeed. Competition is fierce among thousands of blockchain projects, and projects that are no more than scams are also prevalent in the crypto industry. Only a small number of cryptocurrency projects will ultimately flourish.
Regulators may also crack down on the entire crypto industry, especially if governments begin to strongly view cryptocurrencies as a threat rather than just an innovative technology.
And, with cryptocurrencies being based on cutting-edge technology, that also increases the risks for investors. Much of the tech is still being developed and is not yet extensively proven in real-world scenarios.
Despite the inherent risks, cryptocurrencies and the blockchain industry are consistently growing stronger. Much-needed financial infrastructure is being built, and investors are increasingly able to access institutional-grade custody services. Professional and individual investors are gradually receiving the tools they need to manage and safeguard their crypto assets.
Crypto futures markets are being established, and many companies are gaining direct exposure to the cryptocurrency sector. Financial giants such as Square (NYSE:SQ) and PayPal (NASDAQ:PYPL) are making it easier to buy and sell cryptocurrency on their popular platforms, while other companies, including Square, have collectively invested hundreds of millions of dollars in Bitcoin and other digital assets. Tesla (NASDAQ:TSLA) purchased $1.5 billion worth of Bitcoin in early 2021.
While other factors still impact the riskiness of cryptocurrency, the increasing pace of adoption is a sign of an industry maturing. Individual investors and companies alike are seeking to gain direct exposure to cryptocurrency, considering it safe enough for investing large sums of money.
Is crypto a good long-term investment?
Many cryptocurrencies like Bitcoin and Ethereum are launched with lofty objectives, which may be achieved over long time horizons. While the success of any cryptocurrency project is not assured, if a cryptocurrency project achieves it goals, then early investors could be richly rewarded over the long term.
For any cryptocurrency project, however, achieving widespread adoption is necessary to be considered a long-term success.
Bitcoin as a long-term investment
Bitcoin, as the most widely known cryptocurrency, benefits from the network effect -- more people want to own Bitcoin because Bitcoin is owned by the most people. Bitcoin is currently viewed by many investors as "digital gold," but it could also be used as a digital form of cash.
Investors in Bitcoin believe the cryptocurrency will gain value over the long term because the supply is fixed, unlike the supplies of fiat currencies such as the U.S. dollar or the Japanese yen. The supply of Bitcoin is capped at just under 21 million coins, while central-bank-controlled currencies can be printed at the will of politicians. Many investors expect Bitcoin to gain value as fiat currencies depreciate.
Those who are bullish about Bitcoin being extensively used as digital cash believe that, over the long term, Bitcoin has the potential to become the first truly global currency.
Ethereum as a long-term investment
Ether is the native coin of the Ethereum platform and can be purchased by investors wishing to gain portfolio exposure to Ethereum. While Bitcoin can be viewed as digital gold, Ethereum is building a global computing platform that supports many other cryptocurrencies and a massive ecosystem of decentralized applications ("dapps").
The large number of cryptocurrencies built on the Ethereum platform, combined with the open-source nature of dapps, creates opportunities for Ethereum to also benefit from the network effect and to create sustainable, long-term value. The Ethereum platform enables the use of "smart contracts," which execute automatically based on terms written directly into the contracts' code.
The Ethereum network collects Ether from users in exchange for executing smart contracts. Smart contract technology has significant potential to disrupt massive industries, such as real estate and banking, and also to create entirely new markets.
As the Ethereum platform becomes increasingly used worldwide, the Ether token increases in utility and value. Investors bullish on the long-term potential of the Ethereum platform can profit directly by owning Ether.
Should you invest in cryptocurrency?
Owning some cryptocurrency can increase your portfolio's diversification since cryptocurrencies such as Bitcoin have historically shown almost no price correlation with the U.S. stock market. If you believe that cryptocurrency usage will become increasingly widespread over time, then it probably makes sense for you to buy some crypto directly as part of a diversified portfolio. For every cryptocurrency that you invest in, be sure to have an investment thesis as to why that currency will stand the test of time.
If buying cryptocurrency seems too risky, you can consider other ways to potentially profit from the rise of cryptocurrencies. You can buy the stocks of companies such as Coinbase, Square, and PayPal or invest in an exchange like CME Group (NASDAQ:CME), which facilitates crypto futures trading. While investments in these companies may be profitable, they do not have the same upside potential as investing in cryptocurrency directly.
The Motley Fool sought blockchain insights from three finance experts, Dr. Christine Parlour, professor and Sylvan C. Coleman Chair of Finance and Accounting at the Haas School of Business, University of California, Berkeley and Dr. Jimmie Lenz, Director of Duke University's Master of Engineering in FinTech and Master of Engineering in Cybersecurity, and Dr. Merav Ozair, who is a leading blockchain expert and a FinTech Professor at Rutgers Business School.
The Motley Fool: What advice would you give to someone interested in investing in blockchain technology?
Parlour: Be curious but also be cautious. It is important to recognize that there is not a complete regulatory framework in this area. So, it is important to do your homework. First, consider the venue that you use to access the market. There are regulated crypto exchanges and trading places, however there are also unregulated ones. Second, while most tokens are based on open source code, it is not the case that they have the same disclosure regimes as blue chip stocks. So, be careful and investigate the nature of the underlying token. Note that in other countries (Canada, Europe), there are ETFs and ETPs that track crypto portfolios, these have not received regulatory approval yet in the US. If and when they are offered to consumers, these will be a low-cost way of accessing the crypto market and then someone else will handle the market mechanics.
Lenz: Learn and keep learning, the developments in the space are happening at a rapid pace, so much so that new knowledge is being generated constantly. As a professor teaching blockchain this is the hardest part, reinventing the course every semester, but it keeps my students and me as current as possible. This doesn't mean neglecting base knowledge, having this is crucial, as well as some sense of the history to understand why developments have occurred at specific times.
Ozair: Blockchain technology is definitely the future. There is no escaping that. However, it is difficult to predict which projects will last and which will fail and be forgotten.
Most blockchain technology companies are in their early, if not very early stages. Hence, investing in companies utilizing blockchain technologies has all the same risks as investing in a start-up. And like in any start-up, the risk-reward ratio is high.
Therefore, learn about blockchain technology, do a thorough due diligence on any project -- from its technology to business model to execution. Learn about the "problem" it is trying to solve and what solution it's offering -- both from a technological perspective and a business perspective.
There's a lot of potential with blockchain technology, but the execution is in the details.