What investors betting on crypto-currencies should do to minimise risks

Before you bet on them, brace yourself for high volatility and beware of hackers

It’s rare that an exchange sends out a warning about trading in a particular stock or commodity or crypto currency. On Tuesday, the country’s leading bitcoin exchange did just that – sent out an advisory to investors that said: “Due to high demand and low supply of bitcoins, both buying and selling prices are higher in India compared to international prices. Please be cautious since bitcoin prices are volatile and trades are subject to market risk.”

The advisory was issued after the crypto currency tumbled around 20 per cent in three days – from $5,000 to $4,030 on Tuesday morning, triggered by China’s crackdown on initial coin offerings or ICOs. Just a day later, on Wednesday evening, it had recovered sharply to $4,595. Indian exchanges were worried because the premium between global and Indian prices had risen upto 20 per cent, clearly indicating that Indians are rushing in to buy it.
 

Crypto currencies have gained significantly popularity across the world. Around 842 of them (with quoted prices) today command a total market cap of about $166 billion. New ones are being launched almost every day. Japan’s acceptance of crypto currencies as legal tender has contributed immensely to their acceptability. Tech-savvy Indian investors too are climbing on to this bandwagon. However, in view of the novelty of this asset class, they need to acquaint themselves with its risks and invest with caution.

Surging prices: The primary reason for the growing popularity of crypto currencies is the surge in their prices and the high returns they have garnered in recent times. Bitcoin, the most popular crypto currency in circulation, touched a high of $5,000 recently. It has given its investors a return of around 670 per cent over the past one year. Some of the other popular ones have fared even better (see table). “Prices are rising and that is attracting a lot of Indian investors to bitcoin,” says Mohit Kalra, founder and chief executive officer (CEO), Coinsecure, an exchange for buying and selling crypto currencies. “Many tech-savvy Indians in the 30-40 age group are attracted to this alternative asset class and are currently experimenting with it,” adds Sathvik Vishwanath, CEO and founder, Unocoin. According to some experts, supply constraint means that the price of bitcoin may rise further. “The way it has been created, only 21 million bitcoins can be created. About 16 million have been mined already. If demand remains strong, you can expect its price to appreciate over the long term,” says Saurabh Agarwal, co-founder and CEO, Zebpay.

Unregulated and volatile: Investors betting on crypto currencies need to be aware of their risks. Most financial instruments in India fall under the ambit of one of the key regulators – the Securities and Exchange Board of India, the Reserve Bank of India or the Insurance Regulatory and Development Authority of India. In case of crypto currencies, there is no regulatory authority. If something goes wrong, there is no authority you can turn to for redress.

Crypto currencies are also highly volatile. Towards the end of June, a rumour that the founder of Ethereum had been killed in a car crash sparked a 20 per cent decline in its price. News that the bitcoin community was splitting had also led to a sell-off. “Whenever there is adverse news related to a crypto currency, such as of a theft or a scam, its price tends to fall,” says Udbhav Tiwari, policy officer at the Centre for Internet and Society, Bengaluru. Before taking the leap into this asset class, give thought to whether you can stomach such high volatility.

The anonymity of those who buy and sell crypto currencies is another source of risk. If someone steals cash from you, it is difficult to trace that person. Similarly, if somebody hacks into your computer or into the cloud (where your wallet is stored) and steals your crypto currencies, tracing the thief is difficult. "Indian crypto currency exchanges follow a higher level of KYC (know your customer). If somebody from within India steals your crypto currency and tries to sell it on an Indian exchange, it may be possible to trace the stealer," says Tiwari. It is almost impossible if the thief is from outside India.

Several ponzi schemes have mushroomed: Several Ponzi schemes centred around bitcoin have sprung up. “Some elements are promising an 8-10 per cent guaranteed return each month to people who invest in bitcoin through them. Steer clear of them,” says Kalra.

Altogether around 1,077 crypto currencies exist today, with new ones being launched practically every day. After buying bitcoins from an Indian exchange, you can enrol with an international exchange and trade your bitcoins for other crypto currencies. Stick to the established ones. “Many of the new crypto currencies being launched are scams with their promoters just out to raise money from gullible investors. They are not even backed by a white paper (the equivalent of a prospectus in an IPO). Find out about the people and the team promoting the crypto currency because maintaining and promoting the currency are the key to its success,” says Kalra.

Some dealers (not exchanges) may promise you that they will help you purchase bitcoins even if you pay them in cash (normally you do a bank transfer to the exchange). Multiple risks are involved here. “The price they charge you is likely to be higher than what you will get on an exchange. Besides, there is always the danger that they may take the cash and not transfer the bitcoins to you,” says Hesham Rehman, co-founder and CEO, Bitxoxo.

Finally, there is always the risk that the bitcoins you hold could be stolen by hackers.

 

 What should you do? To curtail risk, limit your exposure to crypto currencies. “This is what we call an exotic asset class. Exposure to them should depend on your risk-taking capacity. I would not advise people to invest more than 10 per cent of their portfolio in it,” says Arvind A. Rao, financial planner and founder, Arvind Rao & Associates. Start off by investing a small amount initially that you can afford to lose. Once you have gained experience, take the SIP (systematic investment plan) route. Since it is a volatile product, averaging out the cost of purchase will help. Investors should also not enter this asset class with an investment horizon of less than six months.

Safeguards against hacking

|  Install a good antivirus on the device on which you store your wallet, or from which you carry out transactions
 

|  Ensure that the contents of the wallet are encrypted
 

|  Go with a wallet provider that offers two-factor authentication
 

|  If you own a large number of bitcoins, use an iOS-based mobile device for transacting as they are more difficult to hack