Is Investing in Cryptocurrency Really Safe Right Now?

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Bitcoin (BTC -3.98%) was the world’s first cryptocurrency, and to this day, it’s the most well known. Moreover, since its creation in 2009, it’s been one of the greatest-performing assets. Consider that the price of Bitcoin went up 94%, 302%, and 60% in 2019, 2020, and 2021, respectively.

During periods of superb performance, investors tend to throw all caution to the wind. However, now that Bitcoin and alternative cryptocurrencies are performing poorly, investors are starting to ask whether it’s safe to invest in this space right now. And the answer is no. Investing in cryptocurrency isn’t safe, and it never was. Here’s why.

The problem with cryptocurrencies

Let’s boil the equation down to its basics. If you invest money in a cryptocurrency, it’s because you expect that cryptocurrency to be worth more in the future. But for the price of Bitcoin or alternatives to Bitcoin to increase, there needs to be an increase in demand. After all, crypto’s value goes up when demand outpaces supply.

Therefore, investing in cryptocurrencies is greatly affected by things other investors do. And so far in 2022, we’re learning that reckless speculation has driven an outsized portion of gains.

Technology company MicroStrategy is the biggest culprit, having borrowed $2.4 billion to buy Bitcoin. But MicroStrategy’s actions were out in the open and a known factor. Moreover, MicroStrategy seems well enough capitalized to satisfy its loan terms for now.

By contrast, leverage among retail and institutional investors was less known and apparently more dangerous. Lenders such as Celsius Network have recently been forced to freeze assets as liquidity evaporates. And crypto hedge funds like Three Arrows Capital have failed due to making highly leveraged bets that went wrong. These developments prove there was too much irresponsible leverage in use.

This is a problem for responsible, long-term cryptocurrency investors. The reckless actions of other investors have started a chain reaction of liquidation — it turns out the entire sector is greatly interconnected. And the market capitalization of Bitcoin and others is steadily declining as money consequently flows out.

Therefore, it appears that for many, there wasn’t real demand for Bitcoin and other cryptocurrencies in the first place. Many investors weren’t adopting these solutions but rather speculating on the price. This clearly is not a safe place to invest.

The problems solved by cryptocurrencies

Of course, there’s more to cryptocurrencies than speculation, despite what detractors might say. Blockchain technologies can be used for many real-world purposes.

For example, Theta (THETA -2.28%) aims to build a content delivery network (CDN) for the internet that can be both faster for consumers and cheaper for companies when compared to traditional CDN providers. That’s valuable. And processing transactions on Solana (SOL -2.07%) can be done for a fraction of the fee charged by credit card companies. That’s disruptive.

Theta Labs and Solana Labs are the real-world developer teams behind Theta and Solana, respectively. These teams raise funds from investors, research solutions, and regularly deploy new ideas. Most importantly, what these teams build behind the scenes isn’t subject to the actions of speculators.

The same could be said for something like the Ethereum (ETH -1.69%) blockchain. There are scores of people working on smart contracts, decentralized applications, and more.

Many of these ideas seem worthy of an investment. However, finding a good idea isn’t the same as finding a safe investment. Every cryptocurrency has unique tokenomics — the way the system is designed to incentivize demand for the token and how token supply is handled. A good idea could fail to gain adoption because of poorly constructed tokenomics.

Understanding the nuances of each project’s tokenomics isn’t easy. But it’s an essential first step in avoiding disastrous outcomes when investing in this sector.

What to do

To summarize, investing in cryptocurrency isn’t necessarily safe. Plenty of things could go wrong to decrease the value of the token you buy. Investors of all experience levels need to recognize this.

However, this doesn’t mean that investors should avoid cryptocurrency entirely. Doing things like avoiding leverage, understanding utility, and diving into fundamental tokenomics can go a long way toward mitigating risk.

Keeping a diversified portfolio is perhaps the greatest risk mitigator of all. By allocating only a small percentage of your net worth to investing in cryptocurrencies, you can participate in potential upside without financially setting yourself back if things go wrong.

Jon Quast has positions in Bitcoin, Ethereum, and Solana. The Motley Fool has positions in and recommends Bitcoin, Ethereum, and Solana. The Motley Fool has a disclosure policy.