Know the Risks of Investing in Cryptocurrencies

Christian Catalini is a professor at MIT’s Sloan School of Management and a partner in MIT’s Digital Currency Initiative.

KIPLINGER: What are cryptocurrencies, and why should investors care about them?

CATALINI: Cryptocurrencies are virtual coins that behave very much like a digital form of gold. Both are scarce and can be transferred between people without going through traditional financial intermediaries. Transactions are verified not by banks but by computers that have access to a universal ledger. But unlike gold, which is used for jewelry and has industrial uses, cryptocurrencies have no intrinsic value. They derive and retain their worth from investor demand alone. That demand has grown steadily in the past couple of years, and early investors in some of the most popular cryptocurrencies, such as Bitcoin and Ethereum, have made a lot of money.

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What risks come with investing in cryptocurrencies? Cryptocurrencies are highly volatile and speculative assets. As with gambling, investors wanting to buy them should invest only what they can afford to lose. There are currently hundreds of different cryptocurrencies. In 10 years, many of them probably won’t be around anymore. It’s hard to predict which have long-term, mainstream potential.

What can investors do to minimize the risk? I think many people are rushing to invest in cryptocurrencies without appreciating their complexity. It’s important to research the technical abilities of any currency’s founders, much as venture capitalists do before investing in start-ups. Investors should also realize that if they don’t use robust passwords and other security measures to protect the online accounts they use to buy cryptocurrencies, those accounts may get hacked and their funds may be stolen.

Do you think cryptocurrencies that stand the test of time will become more widely embraced? I think we’ll see more of a coexistence between regular currencies and cryptocurrencies, which I do think come with some ad­vantages. For example, with digital money, if you want to wire money abroad, you’d likely be able to do so at a lower cost. I think countries or financial institutions will eventually adopt the underlying digital-ledger technology that powers cryptocurrencies, called blockchain, to speed up or lower the cost of transactions.