Still, some investors argue they’ve made large amounts of money by investing in cryptocurrencies and other crypto assets, such as early-stage companies. Saeed Al Darmaki, the managing director of Binary Financial, a crypto-brokerage serving high net-worth customers, and managing director of the Dubai-based Alphabit Fund, claimed in a telephone interview that he’s witnessed returns of around 3,000 percent since beginning to invest early in 2017.
On a portfolio basis, while the required outlay for an investor is fairly small, the potential rewards are enormous, he argues. “Let’s say you put 1 percent of your portfolio into crypto, you may stand to lose 1 percent, but actually the returns you can make can double your portfolio. So in that sense it’s worth ‘the gamble’,” he argues.
Nevertheless, one thing that everyone agrees on is that crypto assets are highly risky. Beyond extreme price movements, crypto assets also have regulatory risks, custody risks, and security risks, such as hacking of exchanges or theft from wallets, says Al Darmaki, who previously worked for Abu Dhabi Investment Authority for nine years.
“Don’t invest in [crypto] unless it’s money you can afford to lose. It’s a very risky asset at the moment, highly speculative. Investors have to understand the risk, and do the research on the crypto currencies they want to invest in,” he says.
Unique to cryptocurrencies is that investors probably should have some belief in the crypto ‘story’, namely that blockchain is a game-changing technology that will prove transformational.
“If you’re an investor and you have a long-term horizon, then you have to believe in the fundamentals, otherwise there’s no point in investing,” says Al Darmak.
How to invest
For investors that have decided to take the plunge and are looking for a way to invest in crypto assets, the most obvious way is by buying Bitcoin, the best-known – and most valuable – cryptocurrency. There are a host of other so-called altcoins – Ether, Ripple and Litecoin are among the most prominent.
But most altcoins’ values are highly correlated with Bitcoin, making them unsuitable for investors looking for diversity in holdings. There are also so-called stablecoins, whose values are supposedly linked to a real-world asset.
In its short history since the first block was mined on January 3rd, 2009, Bitcoin has undergone a number of bull runs followed by sharp price declines, frequently losing as much as 80 percent or more of its value at times. While it may not be possible to time the market, if you buy at a peak, you could be left with large losses.
Playing it safe
One prime concern for cryptocurrency owners is security. Ownership of a crypto asset is represented by the possession of a private key, and losing this will also mean you lose possession of your coins. Unforeseen events – such as theft of your computer or a house fire – could result in total loss of your cryptocurrency if you don’t have backups.
Although there are third-party sites offering cryptocurrency storage, these have their own risks. In Bitcoin’s short history, owners have witnessed major losses through theft and the hacking of exchanges.
Rodrigue Afota, the managing director and co-founder of Blocktrust, a custody solutions company in Abu Dhabi, says that there have been so many hacks “because most of the crypto community is young, predominantly IT-inexperienced, with not enough experienced banking skills”.
“There is also a surprising lack of interest for cyber-security best practices,” he adds.
Every crypto-storage solution has downsides: wallets that are online are easier to access, but are less secure, liable to hacking, and involve trusting a third party provider. Hardware wallet options include small dongles that keep private keys offline, but if dongles are lost or stolen, the cryptocurrency goes with it.
For those with significant holdings of crypto assets, they may want a ‘cold-storage’ solution where private keys can be physically stored in a secure vault. These could be accessed across multiple locations and incorporate features such as 24/7 onsite private security, video surveillance and strictly-controlled access, but even these have levels of protection.
“When it comes to safe storage, even cold storage, it is like buying a house: you can get a discounted tent, a hut, a wood shack, a brick house or a castle,” Afota says.
While owning Bitcoin may be risky enough for some, those that want to enter the space more aggressively can look at investing in early-stage crypto companies, which often fundraise through Initial Coin Offerings (ICOs), where coins or tokens are offered to investors for fractional ownership.
Compared with traditional start-up or VC funding, Initial Coin Offerings (ICOs) create instant liquidity – and in some cases, enormous price gains – for investors, Al Darmaki argues.
But given the hype and mania in the industry, many ICOs have been cases of outright fraud: founders absconding with the money without any intention of ever delivering a product. In other cases, founders were unable to deliver on promises and the companies failed, Al Darmaki cautions.
Al Darmaki compares investing at ICO level with traditional angel or VC investing. Investors should scrutinise the idea, the team behind the project, the business model, and also look at whether there is a clear use case for the tokens they are offering for sale, and if the start-up is regulatory- compliant.
As with angel or VC investing, there is a very high failure rate, Al Darmaki warned. “Nine out of ten will fail, but if the one in ten gets you a good return – 10x or 20x – then you've made your money back or you’ve made profit as well.”
One more risk surrounding ICOs is that they are often conducted through jurisdictions such as the Cayman Islands or Switzerland, with companies located offshore, even if the individuals running them are based locally. That can make it impossible to recover funds in the event of fraud or failure.
Ups and downs
While the extreme volatility of cryptocurrencies may be off-putting to many investors it does create opportunities for traders, with 20-30 crypto assets trading at significant volumes, according to the head of trading systems at Relentless 13 Capital, Bruce Powers.
“If you have volume, they pattern and trend exactly like other instruments,” he says in a telephone interview.
Higher volatility means that investors can trade without using leverage, Powers argues. Meanwhile, when back-testing trading strategies, many have shown astronomically higher returns are available trading cryptos than on conventional foreign exchange trading, he says.
Still, trading cryptos should generally only be attempted by experienced traders, Powers says. “With cryptos being the most volatile and therefore the most risky, they would not be the place to start.”
One way of gaining exposure to crypto assets without the risk of direct investment is through managed funds. Al Darmaki says his Alphabit Fund, which was started in 2017 and has $500m of assets under management, has returned 300 percent since the fund’s inception. It is regulated by the DFSA and has Dalma Capital as fund manager.
Dalma Capital is also fund manager for a number of deVere Digital Asset funds, which operate by exploiting arbitrage opportunities in the fragmented crypto market, Zachary Cefaratti, the CEO of Dalma Capital says.
The large number of exchanges, and the number of retail investors with positions in crypto assets means that the market as a whole remains inefficient, Cefaratti says. Using a trend-following system allows fund managers to profit from this, he argues.
“Opportunities may compress in the short term, but medium-to-long term will remain durable for at least the next few years,” he says.
(Reporting by Stian Overdahl; Editing by Michael Fahy)
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