The risk-reward dilemma in cryptocurrencies

The cyberspace and its continuously evolving technologies have advanced rapidly over the last decade. This development has resulted in the creation of a whole new genre of currencies based on cryptography and distributed computing called cryptocurrency. Blockchain is the underlying technology for these digital currencies and is treated as a commodity in countries where they are recognised. Cryptocurrencies are decentralised and cannot be controlled by a central bank, challenging traditional financial systems.
 
Cryptocurrencies aim at minimising transaction charges or “taxes” associated with the transfer of funds by the removal of intermediaries who charge a fee to process transactions. These cryptocurrencies do not have geographical borders or limitations; transactions done globally can be completed in a few seconds with minimal costs compared to traditional financial systems.

 
Can consumers derive optimum value?
 

While banks and financial institutions may be concerned about such advancements in the field of digital currency, how would this affect the common man?
 
Many individuals tend to look for easy, quick and high return on their investments. So bitcoins worth $100 in 2010 are now valued over $70 million! Thus, if you had previously invested in bitcoins, the returns today are much higher as compared to the investments that were made in gold, stocks or any other high-value commodity. Over the past seven years, bitcoins have grown exponentially as compared to other generic investment options available in the market.

 
The thin line between risk and reward
 
While the standard mantra is high risks-high returns, it may not always be the case. Cryptocurrencies have faced a few setbacks on their growth path. In the past, it was difficult to foresee if the share market, mutual funds or the real estate market would ever give good returns; but with time and experience, savvy investors could yield more than traditional bank deposits. However, prudent and potential investors will have to dig deeper to evaluate potential risks such as:
 

• Cryptocurrencies typically operate in a volatile market 

• There is no regulatory framework or governing body to manage them

• Fluctuations in price could result from mining groups refusing their cooperation to create cryptocurrencies, resulting in a high degree of uncertainty 

• Difficulty in recovery of the cryptocurrency if the digital wallet is hacked. 

 

Mining value from the block
 
Cryptocurrencies can be bought from various international exchanges using credit cards or other electronic means. Though there is no official statement regarding the usage of cryptocurrencies in India, many consider it a legal form of exchange. But is buying the only way to acquire them? Definitely not. Cryptocurrencies can also be created by a process called mining, which means adding transaction records to the currency ledger. These records are added to the network in the form of blocks; each time a block is mined, miners earn a reward that subsequently reduces every time a new block is created.

 
Cryptocurrencies can also be mined using the computation power of an individual’s own computer or by joining a public mining pool and supplying their computation power to the pools in return for regular payouts in the form of bitcoins. Another option is cloud mining where organisations enter into contracts to manage the hardware, use data centres and processing power to mine bitcoins on behalf of the users in exchange for a fee. Regular (bitcoin) payments are made to the users throughout the tenure of the contract, with an average return on investment of about 220 per cent. There have been instances where hackers have deployed malware on high-end servers in large data centres to quietly mine for bitcoins.

 
To invest or not to invest?
 
A “successful” cryptocurrency investor is one who understands the landscape and has a high appetite for risk. Maintaining profitability would require constant research, technology acumen and a calculative diversification of investments. While the future of crypto remains fairly undetermined, it may be prudent to stay a cautious player. Investors must also consider the financial impact of the amount in consideration for investment to strike a balance between the amount and volume of risk taken for higher returns.  Arpinder Singh is partner and head, India and Emerging Markets, Fraud Investigation & Dispute Services, EY; Amit Jaju is partner, Forensic Technology & Discovery Services, EY