Cryptocurrency - Is there any substance behind the hype?
Cryptocurrencies are never out of the media, which can give the impression to often young and inexperienced potential investors that they are the next big investment trend.
Indeed, partially due to the financial uncertainty of the pandemic, Bitcoin, for example, hit an all-time high of $60,000 on March 13th 2021, almost more than double the price it was trading at the end of 2020.
When cryptocurrencies spike like this, holders and potential investors (particularly individuals with less investment experience) can often underestimate how risky it actually is.
High risk, uncertain rewards
Cryptocurrencies are extremely high-risk, speculative holdings where the underlying value of an asset cannot be accurately measured. The price is extremely volatile and there is no way of guaranteeing the safety of an investor’s holdings because they have no corresponding value, only the value that the market imbues them with.
For example, since Bitcoin’s $60,000 peak in March, the price has since fallen to $28,000, proving the unpredictability of the cryptocurrency market.
Lack of understanding
Recent FCA research into the prevalence of cryptocurrency investment in the UK found that an estimated 2.3 million UK adults now hold cryptocurrencies, which is a huge increase from the previous year’s figure of 1.9 million. There also appeared to be a shift in attitudes with greater awareness of cryptocurrencies generally, but, concerningly, a corresponding decrease in understanding.
Only 71% of survey respondents who had heard of cryptocurrency could correctly identify its definition from a list of statements, which is a reduction from the previous year’s results. This reveals that misunderstandings regarding cryptocurrency are fairly common, which increases the chance of uninformed investing.
Newer entrants to the market are more likely to:
- Be aged 25 – 44
- Borrow money to buy cryptocurrency
- Regret buying cryptocurrency
- Say that adverts encouraged them to buy when they were already thinking about it.
Given this profile, there is an increased risk of such consumers being vulnerable to poor decision making through a lack of financial capability or resilience, as well as potentially not understanding what they are purchasing.
Outside regulatory influence
In the UK, whilst offering services such as trading in cryptocurrency derivatives does require authorisation, trading of cryptocurrencies is not directly regulated in the UK.
One need look no further than the recent Binance scandal to realise why the FCA’s regulatory perimeter dictates that cryptocurrencies are outside of an authorised adviser’s remit.
How to communicate this to clients
Due to the high-risk speculative nature of cryptocurrencies, the prohibition on the sale of investments that reference crypto assets to retail customers, and the overall regulatory concerns in this space, there is no current way in which firms can be safely involved with cryptocurrency investments. Therefore, the best way to navigate client queries about cryptocurrency is to guide investors towards traditionally reliable forms of investing their money is the best way to mitigate the dangers of cryptocurrency.
However, if a client already holds them through self-directed investment activity, advisors must ensure there is clarity that the holding is entirely outside of the advisory remit.
Of course, not all crypto assets have the same structure, and there is work being completed at national government level in most major economies in respect of the potential benefits that could be provided by other forms of crypto assets. Further change and innovation are to be expected, but for time being they remain an unadvisable form of investing that encourages lucky gambles and inexperienced risk-takers.