Crypto-assets have become increasingly visible as an asset class and has gained a large following.
While some investors are attracted to their accessibility, liquidity, and potential for high growth, crypto-assets are generally regarded as high-risk investments and should be approached with care.
This article will provide a brief overview of what crypto-assets are.
The term ‘crypto- asset’ refers to a variety of digital assets that include cryptocurrency, non-fungible tokens (NFTs), or other digital tokens.
One of the main features of crypto-assets is that they use cryptography to prevent counterfeiting and to keep transactions secure. Another major feature of crypto-assets is that transactions typically occur across a distributed network of computers using a digital ledger (e.g. blockchain).
Crypto-assets can vary widely in their feature. There is not a widely accepted classification system for crypto-assets, and the variety of options is constantly growing.
Below are three examples of crypto assets you might come across:
Cryptocurrencies function as a digital currency represented by digital tokens and transactions being made on a blockchain network. Some cryptocurrencies have additional features like being used to access features on blockchain network or giving holders voting rights on the platform.
Stablecoins are a type of crypto that tries to keep a stable value relative to a fiat currency, or to assets like gold and bonds.
Stablecoins try to keep their value stable by either having 1:1 backing of the asset the coin is aiming to track, maintaining a basket of assets to back the value of the coin, or by using algorithms to manage the supply and demand, and control the coin’s value.
An NFT is a unique digital token, which can record the ownership of an image, digital file or even a real-world asset on the blockchain.
Investors can be attracted to investing into crypto for several different reasons.
Crypto-assets often have low barriers to entry and can be highly liquid, allowing people to buy and sell quickly at little cost (although this can vary depending on the type of crypto and the exchange being used).
Some investors are attracted to the decentralised nature of crypto and want to avoid going though financial institutions or government-controlled entities. This could be because of issues like a financial crisis or political instability damaging trust in those institutions or concerns that they could lose access to financial services.
Some crypto-assets have provided very high growth in recent years. This has attracted many investors hoping that a particular crypto asset will continue to rise in value or hoping to be an early adopter of the next big thing.
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Crypto-assets are considered a high-risk investment. Crypto-assets tend to be extremely volatile, which means the price of the asset can move up and down by large amounts over short periods of time.
While Crypto-assets have the potential to provide high growth, they typically do not provide any cashflow or yield. In most cases, crypto-assets have no intrinsic value or tangible assets to back them, making their value reliant on popularity and speculation. In this instance, the hope is that someone will pay you a higher price than you what you paid for the crypto-asset, based on hype or, potentially, scarcity. It is not based on growth in earnings, profitability or any other traditional valuation methodology, making them hard to predict, with very low reliability of outcome.
While it is true that some crypto-assets have performed spectacularly, these are few and far between. There is no guarantee that the successful cryptos will continue to see such growth.
The high volatility of crypto is not the only risk to consider. The regulatory environment around crypto is still developing, often leaving investors without legal recourse when a crypto-asset or exchange fails. In most cases, an investor is only protected when crypto fits under existing legislation.
Crypto-assets are also vulnerable to being stolen. Exchanges and digital wallets where crypto is traded and stored can be hacked. Crypto based scams are also common.
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The Australian Tax Office (ATO) has provided guidance on how crypto-assets should be treated for tax purposes. As a general rule, the ATO treats crypto the same as most other investment assets. This means that when you sell, gift, or exchange one crypto-asset for another, you realise a capital gain or loss for tax purposes.
Conclusion
Crypto-assets can offer the potential for high returns, but they also carry significant risks, including volatility, limited investor protections, hacking, scams, and uncertain regulation. You should carefully consider whether crypto-assets are appropriate for your objectives, risk tolerance, and broader financial position before investing.
The information provided is factual only, and does not constitute financial advice. If you need to speak with a Financial Adviser before making a decision, you can contact us via the button below.