Digital currencies might be making all the headlines right now, but should you invest your money in them?
Regulators around the world are cracking down on cryptocurrencies and some crypto exchanges. While the deputy governor of the Bank of England, Sir Jon Cunliffe, has raised concern that they could pose a danger to the established financial system.
See more: Bitcoin actually good news
But that hasn’t put off the big technology companies like Amazon and big names like Elon Musk getting involved in crypto.
In this article we explain:
- What bitcoin is and how it works
- Why bitcoin dropped in price in 2021
- Should you invest in bitcoin?
- Things to consider before investing in bitcoin
- Whether you can lose all your money in bitcoin
- How to invest in bitcoin and make money
- Different ways to invest in bitcoin
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What is bitcoin and how does it work?
The concept of digital money that you use online is not that complicated in itself. After all, most of us will be familiar with transferring money from one online bank account to another.
Bitcoin is a digital asset that operates like normal currency with notable differences. Cryptocurrencies are peer to peer payment methods, without the banks taking a cut with every transaction. There are no physical version of the coins either.
Each bitcoin is created (or mined) using an encrypted code, which is a string of numbers and letters. The same equation used to create the code is can “unlock” it (like a virtual key).
Other important points about bitcoin:
- Cryptocurrencies, like bitcoin, ethereum and cardano, are a form of payment that uses blockchain technology to send data in cyberspace
- Each bitcoin must be mined
- It is finite: only 21 million bitcoins that can be mined in total
- Cryptocurrencies are “decentralised” meaning they are not regulated by a financial authority, like a government or central banks
- Most platforms will allow bitcoin purchases using credit cards
Why has bitcoin dropped?
The price of bitcoin and several other leading cryptocurrencies suffered huge falls at the start of December 2021.
Around $10,000 was wiped off the price taking it to $45,000. That’s a long way from the all-time high of $69,000 seen in November.
The recent turmoil follows uncertainty around the latest coronavirus variant and high inflation in the US and UK, as well as threats of further regulation for crypto investments in the future.
Should I invest in bitcoin?
Bitcoin is extremely volatile, but if you are willing to take the risk, first make sure you understand what you are investing in and have a crypto investment strategy.
Also make sure you aren’t investing simply because you have a fear of missing out. There are a number of questions you should ask yourself before getting involved:
- Do I understand what I am investing in and how bitcoin and the crypto market work?
- Am I happy with the level of risk?
- How much more expensive is it now compared to a few months ago? If so, why am I wanting to buy a thing because its price is higher? Where else in my life do I do that?
- Is there any evidence to suggest prices could rise even higher?
- If I buy it now with a view to sell it for even more later, who do I think will buy it from me for that higher price and why?
- If an asset is so great, why was I not interested when it was much cheaper?
- Have I convinced myself that I am in some way “in the know?”
If you don’t have answers to these questions, it’s probably not a good idea to invest. If you do buy bitcoin, make sure you aren’t putting money you need on the line. Read more about cryptocurrency tips (and mistakes to avoid) here.
Things to consider before investing in bitcoin
Like any investment, cryptocurrency comes with risks and potential rewards. Compared to traditional types of investments, cryptocurrency is particularly risky.
Here are some things to think about before you invest:
- We don’t recommend investing all your life savings on cryptocurrency markets
- It’s best to see it a bit like gambling so only invest small amount of your disposable income and be prepared to lose the lot
- Never invest more than you can afford to lose – don’t just think about the short run
- If you haven’t got much money left at the end of each month, it’s best to steer clear of crypto and focus on saving your money instead
Weigh up the pros and cons first:
Pro: Cryptocurrencies are global, meaning they have the same value in every country and no exchange rates.
Con: Cryptocurrencies are extremely volatile, subject to bull runs and market crashes,and so are a very risky investment. People have also reported having to wait to get their cash out because of technical snarl-ups.
The ups and downs of bitcoin
Its hailed by fans as a market-disrupting liberation and demonised by many personal finance experts as a dangerous creation. One things for sure is that bitcoin is volatile.
Since December 2020, bitcoin has enjoyed a theatre of dramatic ups and downs. We outline some of these here: is a bitcoin crash coming?
The problem is that the price of cryptocurrencies is not underpinned by any intrinsic value. It is determined by one thing: confidence, says Mark Northway, investment manager at Sparrows Capital.
So if you decide to invest, be prepared for a bumpy ride.
Can you lose all your money in bitcoin?
Yes you certainly can. Crypto is very risky and not like conventional investing in the stock market.
Bitcoin’s value is based purely on speculation. This is different to company stocks where the share price will move depending on how the business is performing.
Important: Cryptocurrencies are unregulated by the UK watchdog, the Financial Conduct Authority.
There are three main ways to lose all you money with bitcoin:
- The value plummets and you sell: crypto is volatile with its price determined by sentiment. Though technically you only lose money if you sell an investment for less than you bought it for. This is known as “crystallising your losses”.
- Your memory: experts estimate 20 per cent of all cryptocurrency has either been forgotten about or lost with a current value of around $140billion, according to Crypto data firm Chainalysis
- Cyber crime: hackers and scammers are thought to steal around $10million worth of cryptocurrency every day, according to Atlas VPN
Some people choose to take their holdings offline and store it in a physical device called a cold wallet, otherwise known as a hardware wallet or cold storage – similar to a USB stick. While this protects from online attacks you risk losing your holdings.
As with any investment, do your due diligence and don’t pin all your hopes on one company or one cryptocurrency.
Spread your money around so you spread the risk and only invest what you can afford to lose.
How to invest in bitcoin and make money
Like any investment, making money depends on what price you buy and sell an asset for. If you sell when its price is higher than you bought it for, you will make money.
If you sell for a lower price than you bought it for, you will lose money.
- If you had invested in bitcoin at the start of 2020 and sold on 31 December 2020, you would have made a 300% profit
- If you had invested in bitcoin at the start of 2018 and sold on 31 December 2018, you would have made a 73% loss
Bitcoin is extremely volatile so the trick is not to panic and crystallise your losses by selling when its value inevitably falls. This is the same with all investments.
Ways to invest in bitcoin
Buying the coins (or unit of a coin) on a cryptocurrency exchange is the most common way of investing in bitcoin.
But there are other options:
Buy shares in bitcoin-related companies
You could invest in cryptocurrency exchanges or even buy shares in companies that are accepting bitcoin as payment.
You could invest in a bitcoin exchange traded fund ETF. This copies the price of the digital currency, allowing you to buy into the fund without actually trading bitcoin itself.
Invest in blockchain technology companies
You could invest in the blockchain network (the system for recording information about crypto). For example, tech platform Solana claims to be the fastest blockchain in the world.
Several investment companies are launching bitcoin funds.
It will still be volatile, but it could be easier to sell your investment and get your money back than investing directly.
There are also funds that have some exposure to bitcoin as well as traditional assets like shares and bonds.
These are a form of financial derivative that gives you the right to buy or sell bitcoin at a set price (known as a strike price) before a certain date of expiry.
Unlike buying Bitcoin cryptocurrency outright, bitcoin options enable you to take a speculative position (up or down) on the future direction of a market price.
You would buy a call option if you believe the market price would increase:
- If your prediction was correct and the market price increased above the bitcoin option’s strike price, you’d be able to buy bitcoin at the pre-specified price. How far the bitcoin price rose past the strike price determines how much profit you’d make.
- If your prediction was wrong and the price of bitcoin fell, you could let the options contract expire and only lose the premium you paid to open the trade.
Read about Lewis, who taught himself about cryptocurrency and made £8,500 in less than a year after setting up an account with trading platform eToro.
Is bitcoin bad for the environment?
The digital currency uses as much power as the Netherlands every year, with just 30 countries using more energy, according to researchers from the University of Cambridge.
Computers that mine bitcoin use up to 1% of the world’s electricity supply.
While some of bitcoin’s consumption is renewable (an estimated 39%), fossil fuels are still being used to power the mining and servicing of the digital currency.
This is why electric car manufacturer Tesla has stopped accepting crypto payments, causing bitcoin to fall. Find out more in our Guide to eco-friendly cryptocurrencies.
What are the fees when buying bitcoin?
If you want to buy and sell bitcoin, there are usually fees to pay, such as:
- Transaction fees
- Deposit fees
- Withdrawal fees
- Trading fees
- Escrow fees
These usually cost a few percent of the total transaction value.
Do financial institutions support bitcoin?
Governments, regulators and companies are looking closely at bitcoin and other cryptocurrencies.
Companies adopting bitcoin include:
Investment companies that are showing an interest include:
- The world’s largest asset manager, BlackRock, opened two of its funds to the possibility of investing in bitcoin futures
- UK based Ruffer Investment Management added bitcoin to its multi-asset portfolios before pulling out five months later with a $1.1B profit
- In December 2020, one of the world’s biggest index providers, S&P Dow Jones Indices announced it would launch indexing services in 2021 for over 550 of the top traded cryptocurrencies.
The Bank of England (“Britcoin”) and other central banks are exploring the possibility of their own central bank-backed digital currencies.
As more institutional investors get on board with crypto assets for capital gains, this could help to calm dramatic price moves.
Crypto friendly banks UK
Most of the UK’s major banks now let you move money between a regulated crypto exchange and your bank account.
However, some banks are more cautious than others. For example, Starling Bank had imposed a temporary suspension on outbound faster payments to cryptocurrency exchanges in order to protect customers.
The banks are continually weighing up the risks and some make it easier for customers to move money to and from crypto exchanges.
What is Binance and can I still use it in the UK?
The UK financial watchdog has blacklisted cryptocurrency exchange Binance and banned it from carrying out any regulated activity over concerns about its money laundering controls.
The regulator has also ordered the company to stop any form of advertising in the UK.
Binance isn’t based in the UK, so the British regulator doesn’t have the power to stop investors from buying and selling cryptocurrency using the exchange. However exchanges do have to register with the FCA to operate in the UK.
This is a clear warning that investors should be very cautious.
Why are regulators concerned?
The FCA has also warned investors to be wary about companies that promise high returns from cryptocurrency. The nature of investment means that there is never a guarantee of making money.
From January 6 this year the FCA banned the sale of complex derivatives that speculate on cryptocurrency movements.
This means that financial services can’t offer retail customers contracts for difference, spreadbet options, futures and exchange traded notes that focus on digital currencies.
China’s crypto ban
Trading cryptocurrency in China has been illegal since 2019, in what Beijing says is an attempt to stop money-laundering. People could still trade online however on foreign exchanges.
At the end of September 2021, China’s central bank went a step further. It effectively banned cryptocurrencies by announcing all transactions are illegal, warning that it “seriously endangers the safety of people’s assets”. The news knocked $2,000 off the price of Bitcoin.
Banks and payment firms had already been banned from providing cryptocurrency transaction services. On May 18 three state-backed organisations announced there would be no protection for consumers if they lost any money from crypto trading.
The following month, banks and payment platforms were told to stop facilitating transactions while bans were issued on crypto “mining”.
US infrastructure bill
The US government wants to tax and regulate cryptocurrency transactions to help pay for President Joe Biden’s $1trillion infrastructure bill.
However, senators are currently divided on the reporting requirements; the issue is currently being debated and could cause delays to the sign off of Biden’s bill.
It’s thought that a crackdown on crypto could raise tens of billions of dollars to help pay to rebuild roads, railways and improve broadband in the US.
Amazon to accept bitcoin as payment?
If the rumours are true, the technology company could accept bitcoin payments sooner rather than later which could drive the price of the cryptocurrency upwards.
Amazon is also said to be looking at launching its own cryptocurrency.
This comes after Amazon posted a job advert looking to hire someone to develop its digital currency strategy.
Amazon isn’t the only tech giant to be branching into cryptocurrency; there are rumours circulating that Apple will use some of its large cash reserves to invest in bitcoin.
Is there a less risky way of investing in crypto?
“Stablecoins” could be a less risky way of investing in cryptocurrency, according to Gavin Brown, associate professor in financial technology at the University of Liverpool.
Brown points to tether, the largest stablecoin, backed by one dollar per coin. It topped the $50 billion mark on 26 April 2021 but he warns that potential investors shouldn’t necessarily see tether as the next big thing.
“In theory it won’t ever be worth more than a dollar. But it’s potentially an interesting option for any varied portfolio and it could be a slice of stability if [other] things start to suffer.”
The stablecoin has not been without controversy either – being fined by the New York Attorney General and banned from the state the year.
You could also buy shares the companies associated with bitcoin.
There are also some funds and investment trusts that have exposure to cryptocurrencies, which is a less risky way of investing than buying the currencies themselves.
Which are the three biggest cryptocurrencies?
Bitcoin launched in 2009 and remains the market leader. Its market capitalisation — effectively its total worth — is $1.017bn, as at April 28 2021. Ethereum and Binancecome in second and third, with respective market caps of $302bn and $85.5bn.
Find out more in our article: Bitcoin alternatives: the most important other cryptocurrencies
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