Crypto-assets (crypto) also known as cryptocurrencies, coins or tokens are digital assets that do not have a physical form. They may not be backed by physical assets. Crypto is a high-risk investment. This is because it is so volatile, often fluctuating by huge amounts within a short period. As with any investment, you must be prepared to lose what you put in when investing in crypto. In this article, we explore what is crypto and why is it such a risk?
What is cryptocurrency?
Crypto-assets (crypto) also known as cryptocurrency, virtual or digital assets, is an emerging type of asset class. It does not exist physically as coins or notes, but as digital tokens stored in a digital “wallet”. These digital tokens rely on cryptography and technology such as blockchain for security and other features. Crypto may or may not have an actual asset underlying it.
The Reserve Bank of Australia’s website explains how cryptocurrency and blockchain technology works.
Crypto is used for payment systems, to execute automated contracts and run programs. Anyone can create a crypto-asset, so at any given time there can be thousands in circulation.
Why is crypto so volatile?
Crypto is worth what people are willing to pay for it. This means that the price of crypto-assets can fluctuate at extreme levels based solely on market speculation. Factors that can influence the price of crypto include:
- media focus
- public announcements
- the actions of individuals who hold large amounts of a crypto or who influence the price through social media.
How is crypto used?
Crypto-assets were first developed as a digital form of currency, to be used as money. Some stores accept crypto as payment for goods and services and some ATMs let you withdraw it as physical money. However, crypto is not legal tender in Australia and is not widely accepted as payment.
Crypto is more commonly used as a speculative, longer-term investment as most people don’t access their balance for everyday transactions.
How can I buy and store crypto?
You can buy or sell crypto on a crypto trading platform using traditional money. Crypto is kept in a unique digital wallet or hardware wallet.
A user’s wallet has a set of private keys (unique codes) that are used to authorise outgoing transactions on the blockchain network. A wallet may be a software (hot) or hardware (cold) wallet. A hardware wallet stores these private keys on a secure hardware device not connected to the internet. This can protect the user’s wallet from hackers.
If you sell crypto, you must include any investment income on your tax return.
Why is investing in crypto high-risk?
Crypto is not regulated
Many crypto-assets and other digital assets are commonly not considered to be financial products. Because of this, the platforms where you buy and sell crypto may not be regulated by ASIC. This means you may not be protected if the platform fails or is hacked.
When a cryptocurrency fails, investors will most likely lose all the money they put in. In most countries, cryptocurrencies are not recognised as legal tender. You’re only protected to the extent that they fit within existing laws.
The value depends largely on popular opinion
Investing in crypto-assets is highly speculative. The market value can fluctuate a lot over short periods of time and is affected by things like media hype and investor opinion.
The price of crypto may depend on:
- its popularity at a given time (influenced by factors like the number of people using it)
- how easy it is to trade or use it
- the perceived value of the currency
- its underlying blockchain technology.
Your money could be stolen
Be aware that a hacker can potentially steal the contents of your digital wallet.
Your digital wallet has a public key and a private key (like a password or PIN). However, crypto-asset systems allow users to remain relatively anonymous and there is no central data bank. If a hacker steals your crypto-asset, you have little hope of getting it back.
Using a wallet that’s held offline, called a ‘hardware wallet’ or ‘cold storage’, may provide additional protection.
It is technically complex
Crypto-assets can be technically complex and difficult to understand.
Unlike traditional financial products, there is usually no product disclosure statement or prospectus that explains in plain English, and in one place, how the crypto-asset operates.
A crypto-asset’s code may not always be available for users to review. In cases where it is available, it may be written in uncommon or obscure computing languages.
The processes for interacting directly with crypto-asset networks is also unfamiliar to many people. They may require special-purpose software and an understanding of how transaction fees operate. Unfamiliar users run the risk of:
- sending a transaction to an incorrect address
- over-paying on transaction fees called ‘gas’ (sometimes by thousands of dollars)
- not paying enough for a transaction fee (and so losing the fee and transaction).
Crypto scams are increasing
There are two main types of crypto scams.
- Fake opportunities to buy crypto
- Using your own crypto to invest or pay for something
Scammers try to trick people into investing in fake opportunities to buy crypto. Watch out for these tactics:
- false promises of very high returns
- fake endorsement from celebrities or government agencies
- people who contact you through social media or text messages
- using dating apps to establish a romantic connection and gain trust
- multiple or constantly changing bank accounts used for transfers.