Bitcoin is like a sketchy roller coaster at a pop-up carnival. It’s extremely fast, and spectators look nervous, but everyone who’s ridden it has told you that you gotta try it yourself.
As you approach the line, excitement turns to trepidation. You start to notice the ride’s shaky foundation, with a screw or two falling loose after each passing group of riders. You overhear someone in line saying that the ride was recently banned in China and India. Lastly, when you look to see who’s operating the machine, you see that nobody’s there.
The line moves forward and you consider stepping out. But then you see Elon Musk and the Winklevoss Twins in line behind you. That gives you hope, but there’s still a nagging voice in the back of your mind:
Is Bitcoin safe?
There may very well be fun (and money) to be had on the Bitcoin roller coaster, but the risks are real. Warren Buffett once told CNBC that,
“in terms of cryptocurrencies, generally, I can say with almost certainty that they will come to a bad ending.”
What has got Warren Buffet and other traditional investors so nervous about Bitcoin? What are the risks everyone’s talking about? What are risks nobody’s talking about?
Lastly and most pertinently, will your investment in Bitcoin be safe?
Let’s take a closer look at the rickety supports holding up Bitcoin to see if it’s really safe (or, at least, safe enough).
When it comes to investing, “safe” has two meanings
Within the context of traditional investing, the term “safe” usually means “low-risk.”
IRAs, CDs, and mutual funds are considered “safe” investments because you’re almost guaranteed to make money, even if it’s only a trickle (but thanks to compounding interest, a trickle is all you need). Other safe investments may include Blue Chip stocks or a well-priced home with low interest.
But when discussing cryptocurrency, investors often use the term “safe” much more literally. Bitcoin is so new, and so radically different from other investments, that the question “is it safe?” may mean:
- Is my Bitcoin investment figuratively safe, meaning I’ll make a reasonable rate of return?
- Is my Bitcoin investment literally safe from fraud, hacking, theft, etc.?
For most investors, their concerns surrounding Bitcoin trickle into both camps. After all, the potential for a high ROI is rendered pretty moot if your money has a high likelihood of disappearing!
So in this piece, I’ll address both forms of Bitcoin’s “safety.” The two are inextricably linked, after all.
And to kick things off, let’s swing back to our old pal Warren Buffet. What has him and other traditional investors so nervous about Bitcoin?
The #1 reason traditional investors feel nervous around Bitcoin
When Morgan Stanley recently began allowing cryptocurrencies into clients’ portfolios, it wasn’t quite the ringing endorsement some made it out to be.
For starters, only clients with an “aggressive risk tolerance” were allowed to add crypto to their portfolios. They also must have at least $2 million invested with the firm, and of that, only 2.5% of their net worth could be dedicated to crypto holdings.
Basically, Morgan Stanley told clients “fine, you can invest in crypto, but only if you’re ready to lose it.”
Arguably, the bigger story here is that other banks haven’t allowed crypto into client portfolios. Despite the value of BTC exploding from $0.0008 to $50,000 in ten years, investment firms still prevent their advisors from buying crypto for clients.
What has banks and traditional investors so spooked about crypto? It’s not jealousy – it’s probability.
You cannot build an asymmetric risk profile around cryptocurrency
The reason retirement accounts (almost) always make money is because they’re built upon what’s known as an asymmetric risk profile. Basically, whoever’s managing the investments in the portfolio for you has built a “house always wins” scenario.
“You want to have the odds really, really in your favor to win over the long-term. That requires you to collect as much info as possible” says Varun Marneni, an advisor with Atlanta’s CPC Advisors and Raymond James Financial Services.
Investment firms perform a staggering amount of due diligence when investing money, whether it’s their clients’ or their own. Data analytics, complex algorithms, and good old-fashioned research all come into play when designing an asymmetric risk profile.
Now, here’s what has them spooked about Bitcoin.
With more traditional investments, there’s a ton of info out there that investors can use to essentially “predict the future” and handpick the best investments. That’s why good investing is based on skill and less on luck. Data reduces risk.
That’s what has investors so spooked about Bitcoin. It’s based on just about nothing.
“It’s 100% speculation,” says David Hunter, CFA.
As Director of Research and Investments for CPC Advisors and Raymond James Financial Services, a big part of David’s job is to explore ways to predict the future performance of Bitcoin. But because BTC is based on demand only, its future value is as unpredictable as a rare Beanie Baby or a baseball card. It could be worth millions or simply worthless.
The six biggest risks to your Bitcoin investment
Many folks view Bitcoin as a “risk-adjusted” investment, meaning the gains justify the risk it adds to your investment portfolio.
After all, if you bought into Bitcoin at $1,000 and it’s now at $50,000, that’s a 4,900% ROI. That leaves a lot of room for risk to be considered risk-adjusted.
However, when you consider Bitcoin’s enemies at the gates, the rising number of threats to both its value and its very existence, the overall risks involved may start to outweigh even the highest ROI.
Here are just six of them.
1. Bitcoin deposits are not FDIC insured
To restore confidence in the American banking system, the Federal Deposit Insurance Corporation began insuring bank deposits on January 1st, 1934. As a result, only nine banks closed in 1934, compared to 9,000 in the preceding four years.
Fast forward to today and your bank money is insured for up to $250,000. That includes your balance plus interest in the following accounts:
Your Bitcoin holdings, however, are not insured.
So let’s say you have $50,000 in the bank and $100,000 in crypto. Tomorrow, both the bank and the company managing your crypto wallet close-up shop. The FDIC will ensure you get your $50,000 back within days – but your $100,000 may be gone forever.
2. The blockchain can’t be hacked, but exchanges can
Satoshi Nakamoto’s original design for blockchain is equal parts simple and genius. The blockchain, the virtual ledger that stores all Bitcoin transactions and regulates its value, needed to:
- Be safe from outside threats.
- Have a built-in incentive for dedicating CPU power.
- Allow only a trickle of bitcoin to control inflation.
Nakamoto achieved all three objectives by surrounding the blockchain in a protective tornado of computer code. Anyone powerful enough to breach it might as well join it, since they’d be rewarded for “mining” with free bitcoins. Plus, the number of miners would regulate new coins, controlling inflation.
12 years after v0.1 of Bitcoin and blockchain was released on SourceForge, it remains pretty impenetrable. Countless miners have joined it and nobody has destroyed it.
However, to use an apt analogy, a “chain” is only as strong as its weakest link – and although the blockchain has remained safe, the exchanges get targeted all the time.
Since the early 2010s, there have been dozens of “Bitcoin heists” where bad players sneak into exchanges and make off with millions in crypto. Here are just a few of the more high-profile ones, with their USD equivalent at the time of the heist:
- Coincheck, January 2018: $532 million.
- Mt. Gox, February 2014: $470 million.
- BitGrail, February 2018: $170 million.
- Bitfinex, August 2016: $72 million.
- Upbit, November 2019: $50.7 million.
Unlike a traditional bank heist, crypto heists lead to a cascade of further issues for investors, like:
- A drop in crypto values, like Bitcoin losing 50% after the Mt. Gox hack.
- The folding of the exchange, like Coincheck, reducing avenues of investment and causing lost wallets.
- Increased government scrutiny and regulation.
In total, nearly $2 billion was stolen in 2020 alone, according to Security Magazine. And most of it uninsured and unrecoverable. And even if your chosen exchange manages to find your stolen crypto, Bitcoin’s transient nature makes it extremely hard to return to its rightful owners.
Crypto heists are a huge mess – and even if your chosen exchange like Coinbase builds their cyberdefense walls nice and tall, you yourself may still be targeted.
3. Someone could steal your passcode (or you could simply forget it)
But what if someone steals your crypto?
“We get inquiries from people who had their bitcoins or cryptocurrency stolen… on a daily basis” writes Paul Sibenik with cybersecurity firm CipherBlade. “A considerable amount of the time, these individuals think or believed they had an ‘extremely secure setup’ and seek to place blame on other parties.”
But unfortunately, there’s not much you can do if your crypto is stolen. That’s due to a subtle, but critical difference in how crypto exchanges and banks view security.
When a hacker breaches your bank account, the bank sees it as their fault and compensates you immediately. In the aforementioned example, that even extends to circumstances where you leave your credit card on the ground.
But crypto exchanges don’t protect your account like this – rather, they give you the tools to protect it yourself, so if someone breaches your account, it’s your fault rather than theirs. Coin exchanges only protect you from sitewide hacks, and even then, their best efforts may not restore your account to its previous balance à la Mt. Gox.
Sometimes, the security pendulum swings too far in the other direction. In January 2021, The New York Times did a piece on how lost passwords were locking investors out of their Bitcoin fortunes. Some investors have taken so many security measures that they’ve locked themselves out of their own bitcoins safe – and Bitcoin wallets generally have no “Forgot Password?” feature.
There may only be a small sweet spot between locking hackers out and locking yourself out of your crypto wallet. Over time the sweet spot may not exist as hackers find more sophisticated ways to conduct personal wallet theft on a massive scale.
It’s yet another big blow to the literal safety of Bitcoin.
4. Bitcoin is already sucking up more energy than Sweden
Since 2015, over 190 countries have signed the Paris Agreement agreeing to recognize and combat the effects of climate change.
Noticeably absent from the table was Bitcoin or its mysterious founder.
Now, it would be silly to expect a guy (or girl, or team of guys and girls in Guy Fawkes masks) to show up to a global roundtable to represent the Democratic People’s Republic of Cryptostan.
But in the context of the Paris Agreement, it does make some sense because Bitcoin now consumes more energy than Sweden.
Bitcoin’s energy usage isn’t just obscene – it’s rising, and fast. According to the Tech Insider piece, since 2017 alone the amount of power required to maintain the blockchain has doubled to over 100 Terawatt hours. “I think this will be a major problem for Bitcoin,” says Alex de Vries, the economist who created the Bitcoin Energy Consumption Index.
The amount of energy needed to sustain Bitcoin isn’t just a problem for miners, many of whom spend 80% of their profits on power bills alone – it’s a problem for governments.
Anyone who’s signed the Paris Agreement can no longer just shrug off the rising power (literally) of Bitcoin. They’ll have to crack down on its energy consumption, potentially stepping in to shut down commercial mines and threatening the blockchain’s integrity. Inner Mongolia has already shut down its biggest mine and banned future mining in an effort to cut down on emissions – and that’s despite how cheap energy is in Mongolia.
Sure, Jack Dorsey says the future of Bitcoin mining is in green energy, and yeah, some of it is mined in Norway using fjord-powered hydroelectricity (and that’s really cool).
But, his optimistic viewpoint invites two counterpoints of its own:
- The world doesn’t need Bitcoin sucking up green energy resources, either.
- Currently, 65% of the world’s bitcoins are mined in China, which derives the majority of its energy from coal.
5. More countries could ban Bitcoin over time
The list of countries that have banned Bitcoin is small but growing.
India is predicted to follow China’s example in 2021, banning and criminalizing all forms of trading and mining. Bolivia and other South American countries have deemed all crypto activity illegal, as have North African nations Algeria, Egypt, and Morocco.
The list of countries giving crypto the thumbs up is equally small. Denmark, the United States, and the United Kingdom have all given it the go-ahead. Germany’s considering it.
Most other countries fall somewhere in the middle. The governments of Colombia, Ecuador, Canada, Saudi Arabia, Jordan, Qatar, Iran, Bangladesh, Taiwan, Cambodia, Vietnam, and more have made cryptocurrency illegal in some capacity, telling banks and businesses to stay away and banning it as a form of currency.
The global consensus on Bitcoin is, as the pollsters say, “too early to call.”
Many in the crypto community say that world governments will lift trading bans just as soon as they figure out how to tax it. But that day may never come; the IRS declared Bitcoin taxable in 2014 and in the following years, less than 0.08% of crypto traders paid taxes.
It eventually took the IRS seven years to develop a system for tracking down crypto tax dodgers using blockchain analytics. But these crypto tax tools are undoubtedly extremely expensive and out of reach to most nations. And if they can’t tax it, governments are never going to let Bitcoin into their economies willingly. No country would knowingly create a playground for fraud and tax evasion.
Even if we zoom out a bit, there’s very little reason for any country to accept Bitcoin. Even if they can effectively tax it, Bitcoin is still a resource hog, an economic liability, and it distracts retail and institutional investors alike from investments that directly stimulate growth, like private industry, green energy, and government bonds.
6. A “Bitcoin winter” could be coming
Perhaps the biggest “safety” risk of all is that your Bitcoin investment simply won’t make money.
Sure, the value of a single BTC has been steadily rising since 2009. It may have suffered stagnation from 2018 – 2020, but it’s already rallied and then some, peaking at 600% of its pre-bubble valuation.
Surely it’s going to keep going up.
Well, to borrow another apt analogy, sorry to be the one to burst your bubble.
Remember, Bitcoin as an investment vehicle isn’t like a stock or a plot of land. There’s no P/E ratio, no earnings reports, no rising federal interest rate to base its past, current, or future performance on. Its value isn’t based on anything intrinsic or even predictable.
Bitcoin is valuable for the same reason Paris Hilton is famous. It just… is.
Prominent Bitcoin investors are warning others of an impending “Bitcoin winter,” which is like a bubble burst but longer. Bitcoin could very well hit $100,000, even $300,000 by the end of 2021 – followed by a precipitous crash.
“In the crypto industry, we call it Bitcoin winter and it can last for two to three years,” Bobby Lee, co-founder and former CEO of crypto exchange BTCC, told CNBC. “People should be aware that it could fall as much as 80% to 90% of its value from the all-time peak.”
In summary, investors should be careful not to bet on Bitcoin because “the upside is worth the risk,” because it’s easy to forget that the upside may not exist in the first place.
Like a rickety roller coaster, Bitcoin is fast, exciting, and thrilling even just to spectate. But neither the happy riders nor the long line should lure you into a false sense of security.
If you’re feeling nervous about a Bitcoin investment, or increasing your investment, your feelings are 100% valid. The Bitcoin roller coaster is both literally and figuratively unsafe for at least the following reasons, paraphrased:
- Bitcoin isn’t FDIC insured because it’s too volatile to be a currency.
- Bitcoin exchanges can be hacked, and even recovered BTC won’t be returned to you.
- Your crypto wallet passcode can be lost or stolen.
- Bitcoin is consuming way too much global energy and resources.
- Lacking resources to tax it, more countries may ban Bitcoin.
- The current bull run could lead to a “Bitcoin winter” with values plunging 90%.