Sharp falls in the value of Bitcoin this week provided a brutal reminder that investing in cryptocurrencies is definitely not for the faint-hearted.
The price of Bitcoin plummeted to below $33,000 on Tuesday, nearly half the record $63,000 price it reached in mid-April. Other cryptocurrencies such as Ethereum and Dogecoin followed suit, registering losses of 10%-25%. Prices subsequently showed signs of recovery after El Salvador became the first country to announce that it would accept Bitcoin as legal tender.
Here, we explain how cryptocurrencies work, and why it’s essential to understand the risks involved if you’re considering investing.
How does Bitcoin work?
Whereas normal currencies are supplied by a central bank, cryptocurrencies such as Bitcoin are created by a process known as ‘mining’, which involves using computers to solve complicated algorithmic searches. Bitcoin prices can fluctuate wildly, and movements are often driven by speculation, regulation, and negative or positive news dampening or boosting sentiment. For example, Tesla-owner Elon Musk’s purchase of $1.5bn of Bitcoin in February this year pushed prices higher, only for them to fall after he announced that he was suspending vehicle purchases using Bitcoin due to climate change concerns. The process of mining the cryptocurrency uses huge amounts of electricity each year, often generated by coal.
Susannah Streeter, senior investment and markets analyst at Hargreaves Lansdown, said:
“This latest sharp fall in a matter of hours underlines how volatile the currency is, and how it’s swaying in price swept by conflicting appetites for crypto across the world.
“Although it’s clear that cryptocurrencies in some form will find a place at the table in the financial system, given the interest by large companies and governments, it’s very unclear which of the thousands of cryptocurrencies will retain their value in the future and what role they will play.”
Earlier this year, the city regulator the Financial Conduct Authority (FCA) warned about the risks of investing in cryptocurrencies, urging potential investors to make sure they fully understand what they’re investing in, and to check whether any firm they are considering using is on the Financial Services Register.
Kevin Brown, savings and investment specialist at Scottish Friendly, said: “The level of volatility means that savers who choose to invest into cryptocurrencies must be prepared to lose all their money. The FCA has already urged extreme caution and it’s important that people take heed of this warning.
“At least when you are at the bookies you have a real chance of understanding the outcome and probabilities if you know the horses or football. If you do decide to invest in crypto, then only do so with money you can afford to lose. For everyone else, investing should begin with the stock market and the creation of a diversified portfolio with exposure to different assets. This helps to balance out the risks and maximise your potential returns.”
Watch out for cryptocurrency scams
Fraudsters are increasingly using social media platforms such as Facebook and Instagram to persuade people to invest in fake cryptocurrencies. Over £63m was lost nationally between April 2020 and March 2021 by victims of investment fraud who referred to a social media platform in their report to Action Fraud, the national reporting centre for fraud and cyber crime
Action Fraud says that 5,039 reports of investment fraud referred to a social media platform, with 44.7% of reports stating the fake commodity they had been scammed into investing in was a type of cryptocurrency.
A spokesman for Action Fraud: “Fraudsters present professional and credible looking online adverts, send emails, and create websites to advertise fake investment opportunities in cryptocurrency, foreign exchange trading and bonds.
“Often, fake testimonials are accompanied with a picture of a well-known figure to help the investment seem legitimate. Between April 2020 and March 2021, Action Fraud received over 500 investment fraud reports which made reference to a bogus celebrity endorsement, with losses reaching over £10m.”
If you think you’ve fallen victim to a cryptocurrency scam or any other type of fraud, report it to Action Fraud as soon as possible online at www.actionfraud.police.uk or by calling 0300 123 2040.