For those stepping into the unknown, it is important to note there are some very real dangers facing crypto traders:
- In India, it’s likely that the government will soon regulate this activity and demand a greater pound of flesh. While traders are already liable to pay capital gains tax, one would not be surprised to see a higher rate announced soon for crypto trading, given its fundamentally speculative nature. One risk is a very high rate of taxation. Another is that the government first tries to fight it by banning it. Which will drive the activity underground and may expose retail traders to elements that they would normally not deal with.
- Given that there is no real store of value in tokens and they are not really backed up by any hard asset, any crash can snowball into a giant whirlpool. Sucking up investor wealth before they know what is happening. And no central bank or government is going to step in to either bail anyone out or stem the volatility. In such a scenario, simply holding onto a token in the hope that value will recover may not be an option for anyone.
- Given their fundamental nature, crypto currencies are highly vulnerable to hacking and technological glitches. Make one typo while moving tokens between wallets and you can lose them forever in hyper space. Use a wallet with poor security and an international hacker may happily walk away with your tokens. When that happens, there is no one you can go to. You can’t appeal to the government. You cannot really register a police complaint. You’re in the wild west of the financial markets and traditional law and order has not yet arrived here.
- Server farms set up to “mine” coins suck up a huge amount of electricity and generate tons of heat. Most countries provide their citizens with some form of subsidized power that has a massive environmental cost. The long term real cost of power and environmental damage is not being assessed by anyone today.
- When you deal with the equity markets, there are regulators as well as checks and balances in place to prevent market manipulation and insider trading etc. However, in the world of crypto currencies market manipulation is pretty much par for the course. Large players holding huge reserves of tokens and cash in the crypto space are known as “whales” and they get together to pretty much make the price of a targeted token swing in the direction they desire. Unless retail traders can train themselves to recognize the signs and join the swing, they are likely to become the krill who feed the whales!
- Unlike fiat currency, there is no control on how many coins or tokens can be launched. As of Jan 2018, there were over 1400 crypto currencies in the market and growing. It’s quite obvious that all of them are unlikely to survive. And there’s nothing stopping more from being added on. Something like Bitcoin which was the grand daddy of all tokens is now considered “old” technology by some. Does this mean that every coin will have a life span and be replaced someday? In that case, how does the store of value shift to new tokens? No one really knows how this is going to play out.
- Given its fundamentally decentralized nature, crypto currencies are almost impossible to track and hence prone to misuse for money laundering and illegal activities. Anyone can produce a few bitcoins on a hardware ledger and claim that they “mined” it themselves. Or that they bought it when it was 20 cents and it is now 20,000 $. But to try and combat this by banning them would be a mistake. It’s like they say about electricity. Just because it can give you an shock and kill you, does not mean you stop using it, do you? You learn how to harness its power in the best possible way.
- Beyond all this, it appears that the financial equivalent of a confirmation bias is fully at play here. The market keeps going up because everyone wants to believe it will. Even though it is volatile and forms peaks and troughs, its overall trajectory has been upward for a very long time. This allows people to fool themselves into thinking that they are actually expert chart readers and technical analysts. The number of people talking complex chart talk like fibonacci curves and stochastic analysis etc out there is mind boggling. Fact is that if the market cracks suddenly, all the analysis will be replaced with panic overnight. It is very important to stay real and realize that one is riding a wave.
First things first.. What really is cryptocurrency? To quickly (& crudely) simplify a complex topic, these are unique digital entities (lets call them tokens) based on blockchain technology. A technology that has been designed so that a token can never be replicated and retains its unique identity all along. Once assigned a notional value (much like a piece of paper is assigned value in traditional currency) it continues to be associated with some value forever, due to its unique identity. Cryptocurrencies are believed to have been created by technologists as a decentralized community-owned alternative to the current system where central banks print currency and governments bail out entities based on their whims and fancies.
How do you lay your hands on one? There are two ways. Either you digitally “mine” a coin or you buy them on one of the many coin trading exchanges that have now been set up across the world. Digital mining is an interesting “self propelling” process where you devote a certain degree of computing power to the coin, in a sense “searching” for undiscovered coins in the internet space. The coin algorithm uses this compute power to perform the tasks of unique identification for the coin in daily usage and in return for the compute power you have devoted, you get rewarded with more coins (which are auto restricted in number)! People have now set up huge server farms devoted to this function. The easier and most common way of course, is to sign up to a coin trading exchange and buy the coins for cash. People then tend to engage in a popular activity called crypto currency “trading”.