Decrypting new ways of investing

Stories around cryptocurrencies abound in the media. Dr Benjamin Holdsworth warns of the ten points you should remember about digital assets.

Blockchains, Web3, the meta­verse, NFTs, cryptocurrencies, Bitcoin, Dogecoin, dApps and DAOs. These terms have surged into mainstream media from nowhere over a decade ago. 

At the time of writing, the total value of crypto assets, if instantaneously and in a costless manner converted to US dollars, sits at around $2trillion. To provide some perspective, Microsoft’s total market capitalisation currently sits at around the same figure. Are crypto assets now too big to ignore? 

Here we explore ten important points to remember if considering an allocation to digital assets. 

1Complexity and perceived sophistication do not make something a good investment

An innovative product will not necessarily be revolutionary. There are many highly technical solutions in the digital assets space with exciting prospects, but without the benefit of hindsight it is impossible to know what technologies will become commonplace. 

For most, it is not necessary to gain an in-depth understanding of the mechanics and nuances of digital assets and blockchain technology. 

Many people drive cars without a detailed knowledge of how the gearbox works or how the engine uses the fuel to generate power. It is, however, useful to understand some high-level characteristics and considerations.

2There are legitimate challenges to the future of many digital assets

A philosophical debate exists around what designates an asset’s ‘value’. What gives a verifiably ‘owned’ 600×600 digital image – which can be infinitely reproduced – worth? 

Why is a bitcoin, with little use in daily life and not in physical form, valued at tens of thousands of dollars based simply on its verifiable scarcity? Why Bitcoin and not any of the other 10,000 or so crypto­currencies? 

How can widespread adoption get round the challenge of high transaction fees and slow transaction times? For example, Ethereum – another decentralised blockchain – can only process up to around 30 transactions per second, while Visa claims capacity for over 65,000. 

It is difficult to give firm answers to these questions, although they are valid challenges for these technologies to overcome to achieve mainstream adoption. 

3Beware fraudulent activity

Hacks and outright theft are real risks that exist in the space, with little-to-no route to compensation for investors. 

Currently, there do appear to be some significantly vulnerable points – in the process of purchasing digital assets – whereby illicit activity occurs at a cost to investors. Examples of hacked wallets, stolen funds, corrupt exchanges and fake cryptocurrencies are frequent in financial media. These are unfortunate realities that exist. 

4Transaction costs are high 

Owning digital assets directly can be costly. Transaction fees are high and liquidity could reasonably be an issue, particularly at the time of large market swings. There are limited options to buy pooled investment products to gain exposure to digital assets and those that are available are expensive.

5Much of the digital assets’ world is unregulated

A reasonable starting point as an investor is to first avoid any investment that is unregulated. 

A lack of regulation gives rise to increased risks of criminal activity at a cost to the investor, and most likely an investment in which it is more difficult to know the true inherent risks. 

Much of the digital assets’ world is unregulated. This may change in time, though the very nature of true decentralisation makes it difficult for a central regulator to engage in necessary oversight.

6Environmental impact concerns are valid and material 

Although the digital assets’ industry is broadly aware of the issue and has taken steps to improve the climate impact, it is still significant. 

The method of verification of bitcoin transactions is energy intensive, as miners compete for newly minted bitcoins by producing the most powerful processing units. 

The Cambridge Bitcoin Elec­tricity Consumption index provides some interesting compar­isons, such as the fact that the estimated energy usage from mining bitcoins is comparable to the energy usage of countries such as Poland and comprises over 0.6% of global energy consumption. As another example, energy consumption of the bitcoin network in a single year could power all kettles in the UK for over 30 years.

7There have been some great innovations 

There is no doubt that there are some exciting and potentially disruptive innovations in the space.

The challenge investors face is that, without the benefit of hindsight, it is impossible to know which innovations will prevail.

8Many investors can benefit from indirect exposure to digital assets 

By owning a diversified basket of securities, one can own the public companies that are developing, selling or implementing the new technology. 

Investors calculate the expected future cash flows of firms – giving them a market value – and so owning these firms in a market weight gives investors the aggregate view of each company’s future.

9Ownership of many digital assets comes with a highly volatile journey

Significant price swings are regular in the world of digital asset ownership. 

In the past five years, the price of a bitcoin has seen daily movements of up to +26% and down to  39%. 

It’s a very bumpy ride.

10Remember the tax consequences of ownership 

Many investors are unaware of any potential tax liabilities that may arise due to ownership. 

A nationwide survey in the US by Wakefield Research – commissioned by CoinTracker – found that just 3% of respondents correctly answered a list of questions relating to when crypto investors would be liable to pay tax. Proceeding without due caution can land investors in hot water. 

Revolutionary technological advancement is a brilliant consequence of the capitalist system, and a key factor in economic growth. 

The world of digital assets and blockchain technology is exciting and it would not be entirely surprising to see some of the innovations – many of which might not even exist today – become commonplace. 

There is, however, a relatively deep technical knowledge required to understand digital assets, even at a basic level. This does not make them a simple investment, and any consideration about cryptocurrencies should be fully explored with the backing of solid financial advice.

Dr Benjamin Holdsworth (right) is a director of Cavendish Medical, specialist financial planners helping consultants in private practice and the NHS

The content of this article is for inform­ation only and must not be considered as financial advice. Cavendish Medical recommends that you seek independent financial advice before making any financial decisions. Levels, bases of and reliefs from taxation may be subject to change and their value depends on the circumstances of the investor. The value of investments and the income from them can fluctuate and investors may get back less than the amount invested.