Unless you’ve been living under a rock for the last couple of years, you’ve probably heard of cryptocurrencies like Bitcoin, Ethereum and Ripple. These are some better known examples of cryptocurrencies, also known as virtual currencies or digital currencies. Anyone can create a digital currency, so at any given time there can be hundreds, or even thousands in circulation. They can be bought or sold on an exchange platform using conventional money.
Cryptocurrencies were created as an alternative payment system to traditional currencies. They were not intended to be investments; however, this is mostly what they have been used for. As an investment, they are highly speculative as there is often very little, if anything, underpinning the value of the currency.
The value lies in what is called the blockchain technology used to create the currency, and the application of that technology in the broader community. For example, financial institutions have been looking at how they can use blockchain technology for everyday electronic payments.
Some early adopters, those who took a gamble early on, have made substantial profits. We say gamble as they could just as easily have lost their money.
When you hear about people making extraordinary profits from something new it’s natural to want to jump on board. You decide to take a leap and use real money to buy into a cryptocurrency. The problem is that tens of thousands of people just like you have had the same idea and when the demand for any commodity increases, so does the price. The following graph shows the value of Bitcoin, Ethereum and Ripple over the last 3 years.
Let’s say you got in early and three years ago you spent $5,000 to buy 20 Bitcoins. Two years later your investment was worth a whopping $467,000! You held onto it as the market slid and now it’s only worth $112,000. Still an incredible return over three years but you’re kicking yourself that you didn’t sell at the peak of the market. Hindsight’s a fabulous thing.
But, let’s say you only jumped on the band wagon a year ago and paid $20,000 for a single Bitcoin. It’s now only worth around $5,600 and you’ve lost 72% of your investment!
Many of these virtual currencies have started worth next to nothing, peaked and are now virtually worthless again. Buying into a cryptocurrency really is a gamble, so like any bet, don’t put in more than you are prepared to lose.
For more information on cryptocurrencies visit moneysmart.gov.au.