Crypto currency investors appear to be playing “Russian Roulette” with their money, according to AJ Bell’s Laith Khalaf, who pointed to a study suggesting they tend to be inexperienced and completely unaware of the risks they are taking.
Cryptocurrencies have been making headlines this year, with Dogecoin’s market cap rising by 800 per cent, or $7bn, in a single day after attracting the attention of a Reddit group similar to the one that caused the GameStop ‘short squeeze’. Meanwhile, Bitcoin rose 17 per cent yesterday after Tesla bought a $1.5bn stake.
Performance of Bitcoin over 5 days
Source: Google Finance
Yet while people have flocked into these assets in the hope of making similarly easy gains, a study conducted by findoutnow on behalf of AJ Bell suggested that they tend to have little to no knowledge of investing.
Of the 1,134 cryptocurrency holders who spoke to findoutnow, 58 per cent don’t have an ISA, 53 per cent don’t have a pension and 23 per cent have no form of savings.
Khalaf, a financial analyst at AJ Bell, said this suggests a generation of young people have “leapfrogged traditional savings and investments and jumped straight into the deep end”.
“There are a number of concerning findings from our research,” he added. “Not only are many consumers buying cryptocurrencies without having an ISA, pension or savings account in place, there also seems to be a significant misunderstanding of the risks involved.
“Thirty per cent of cryptocurrency investors are not willing to lose any of the money they’ve invested, which suggests they lack an appreciation of the potential downside.
Source: AJ Bell/findoutnow
“Only one in four would be willing to lose 75 per cent or more of their investment, which is not beyond the bounds of possibility, given the volatility of the asset class. Indeed, in January the Financial Conduct Authority warned consumers that they should be willing to lose all of their money if investing in crypto assets.”
The survey also indicated that the most popular reason for buying cryptocurrencies was to capitalise on digital trends, with just 11 per cent of respondents saying they bought them to make digital payments.
“Both of these are sound reasons for buying cryptocurrencies, provided it’s only a small amount of an otherwise diversified portfolio,” Khalaf said.
“Our research suggests there are some investors who are buying cryptocurrencies in a sensible manner with their eyes wide open to the potential losses.
“But these measured crypto investors seem to be the exception rather than the rule,” he added, pointing out 19 per cent of survey respondents bought cryptocurrencies on the back of rising prices, which suggests they are partly relying on past performance being repeated, “a heroic assumption”.
The analyst said that the unpredictability of cryptocurrencies’ long-term future makes allocating money to these assets more akin to speculation than investment. For example, he said that while it is certainly possible the price of Bitcoin will be significantly higher in 10 years’ time, it is also possible it will be close to worthless.
“It’s such a new and evolving market that no one can predict with any confidence which one of these scenarios, or any in between, might prevail,” he continued.
“The same is not true of investing in the stock market. While there are no guarantees, there’s a very good chance that over 10 years you will make a positive return from an investment in the stock market.
“For novice investors, a simple, low-cost tracker fund, purchased in an ISA, will likely fit the bill. Investing is about gradually building up a nest egg, rather than getting rich quick.
“If you’ve never been tempted to trade movements in traditional currencies like US dollars, Japanese yen or the Argentine peso, you should question what has led you to consider investing in a digital currency which is much more volatile.”
Khalaf said the enthusiastic take-up of cryptocurrencies among celebrities appears to be exacerbating the stampede into these assets. Dogecoin rose to a record high yesterday, which has been partly attributed to Tweets from rapper Snoop Dogg, Tesla chief executive Elon Musk and Gene Simmons of rock band Kiss, who said: “Yes, I bought a big position in Dogecoin.”
The analyst said that while no one can doubt Musk’s exceptional record of achievements, for example, investors should stop and consider the downside before following him into cryptocurrency.
But don’t take Khalaf’s word for it – take Tesla’s. On 8 February, an excerpt from a US regulatory 10-K filing by the company said: “The prices of digital assets have been in the past and may continue to be highly volatile, including as a result of various associated risks and uncertainties.
“For example, the prevalence of such assets is a relatively recent trend, and their long-term adoption by investors, consumers and businesses is unpredictable. Moreover, their lack of a physical form, their reliance on technology for their creation, existence and transactional validation and their decentralisation may subject their integrity to the threat of malicious attacks and technological obsolescence.
“Finally, the extent to which securities laws or other regulations apply or may apply in the future to such assets is unclear and may change in the future. If we hold digital assets and their values decrease relative to our purchase prices, our financial condition may be harmed.”
Khalaf added: “If you’re the world’s richest man, investing $1.5bn of the assets of your electric car company into Bitcoin is one thing. Musk can afford to lose a few quid if things don’t go to plan, [but] not everyone else is in the same boat.
“UK consumers seem to be playing Russian roulette with their money on the cryptocurrency markets,” he finished.
In a recent article on Trustnet, Gary Potter, the co-head of BMO’s multi-manager team, warned that asset bubbles are likely to deflate this year as the opening of the real economy attracts money that flowed into financial instruments in 2020.