Figuring out whether it is worth investing in bitcoin and other cryptocurrencies
Cryptocurrencies had a particularly turbulent time in 2022, with the price of bitcoin dropping below $16,000. But there are signs that the crypto market is starting to recover.
The price of bitcoin has surged 90% since its lowest point last year and is now worth around $30,000. So should you steer clear of the notoriously volatile asset or have faith that it can make a comeback?
What is bitcoin and how does it work?
The concept of digital money that you use online is not that complicated in itself.
Cryptocurrencies like bitcoin are digital assets that operate similar to normal currency, but with significant differences. They use peer to peer payment methods, without the banks taking a cut with every transaction, albeit if you are using a broker they will likely be taking a cut for every transaction. There are no physical versions of the coins either.
Each bitcoin is created (or mined) using an encrypted code, which is a string of numbers and letters. The same equation used to create the code can “unlock” it (like a virtual key).
Other important points about bitcoin:
Cryptocurrencies, like bitcoin, are a form of payment that uses blockchain technology to send data in cyberspace
Each bitcoin must be mined
It is finite: only 21 million bitcoins that can be mined in total
Cryptocurrencies are “decentralised” meaning they are not regulated by a financial authority, like a government or central banks
Most platforms will allow bitcoin purchases using credit cards (bear in mind that your credit card provider may charge you a fee to do this or may indeed not allow it).
Why did bitcoin crash in 2022?
The price of bitcoin and several other leading cryptocurrencies followed a downward trajectory throughout 2022.
Rising inflation and interest rates are perceived by many to have caused cryptocurrency to fall along with many stocks and shares as investors dial down the level of risk they are taking on.
In November 2022, the price of bitcoin fell below $16,000, according to Coinbase*.
Since the start of 2023, the market has been recovering, with one bitcoin now worth around $30,000.
While it’s still a long way from the all-time high of $69,000 seen in November 2021, many crypto investors are hoping that 2023 will be kinder to them.
Recent market turmoil has been caused in part by:
The collapse of major cryptocurrency exchange FTX after it struggled to find a buyer to rescue it. This has had a knock-on effect on other crypto exchanges
Uncertainty around rising interest rates in the US and UK, causing a sell-off in risky assets
A cost of living crisis caused by rising inflation means that investors have less disposable income to spend on buying bitcoin and other cryptocurrencies
China making cryptocurrency transactions illegal
Why is bitcoin going up?
So far, 2023 has been good to crypto investors, with the price of bitcoin currently at around $30,000. That’s an 82% increase since the start of the year.
There are a number of possible causes of this rally. Inflation in the UK and US is forecast to fall throughout 2023, meaning central banks could bring down interest rates. This has boosted confidence in both crypto and stock markets.
The collapse of the FTX exchange also triggered a crypto crash and many thought there was no way back for cryptocurrency. With the worst of this saga now behind investors, some may have a renewed sense of confidence.
However, there is fear that the recent spikes in price are due to market manipulation from investors who have a particularly large amount of money invested in cryptocurrency. When these types of investors buy and sell large amounts of cryptocurrency, prices can swing significantly.
Will bitcoin ever fully recover?
It is impossible to say whether bitcoin will recover back to the heights we saw at the end of 2021.
The price of crypto is based purely on speculation, making it difficult to predict what the future holds for this volatile asset. In other words, bitcoin’s performance is likely to depend on how the crypto crowd is feeling.
Bitcoin previous performance might give some investors confidence of a full recovery. In 2018 bitcoin plunged by 83% before going on to reach fresh record highs in 2020 and 2021. People having built up some savings during lockdown helped the price prop up.
But there are no guarantees that bitcoin’s price will return to the levels seen in November 2021 when it reached $69,000.
Should I invest in bitcoin?
Bitcoin is extremely volatile and high risk.
If you are willing to take the risk, first make sure you understand what you are investing in, have a crypto investment strategy and have considered obtaining appropriate financial advice.
There are a number of questions you can ask yourself before getting involved:
Do I understand what I am investing in and how bitcoin and the crypto market work?
Can I afford the level of risk?
Is there any evidence to suggest prices could rise even higher?
If I buy it now with a view to sell it for even more later, who do I think will buy it from me for that higher price and why?
If an asset is so great, why was I not interested when it was much cheaper?
Have I convinced myself that I am in some way “in the know?”
If you don’t have answers to these questions, it’s probably not a good idea to invest. If you do buy bitcoin, make sure you aren’t putting money you need on the line.
Things to consider before investing in bitcoin
Like any investment, cryptocurrency comes with risks and potential rewards. Compared to traditional types of investments, cryptocurrency is particularly risky.
Here are some things to think about before you invest:
It’s best to see it a bit like gambling – only invest small amount of your disposable income and be prepared to lose the lot
Never invest more than you can afford to lose
The ups and downs of bitcoin It is hailed by fans as a market-disrupting liberation and demonised by many personal finance experts as a dangerous creation. One things for sure is that bitcoin is volatile.
Since December 2020, bitcoin has enjoyed a theatre of dramatic ups and downs. We outline some of these in is a bitcoin crash coming?
The reality is that the price of cryptocurrencies is not underpinned by any intrinsic value. It is determined by one thing: confidence, says Mark Northway, investment manager at Sparrows Capital.
So if you decide to invest, be prepared for a bumpy ride.
Can you lose all your money in bitcoin?
Yes you certainly can. Crypto is very risky and not like conventional investing in the stock market.
Bitcoin’s value is based purely on speculation. This is different to company stocks where the share price will generally move depending on how the business is performing.
Important: cryptocurrencies are unregulated by the UK watchdog, the Financial Conduct Authority. Crypto platforms are only regulated for anti-money laundering purposes.
There are four main ways to lose all you money with bitcoin:
The value plummetsand you sell: crypto is volatile with its price determined by sentiment. Though technically you only lose money if you sell an investment for less than you bought it for. This is known as “crystallising your losses”.
The cryptocurrency goes bust: the cryptocurrency loses all its value
Your memory: experts estimate 20 per cent of all cryptocurrency has either been forgotten about or lost with a current value of around $140billion, according to Crypto data firm Chainalysis
Cyber crime: hackers and scammers are thought to steal around $10million worth of cryptocurrency every day, according to Atlas VPN
Some people choose to take their holdings offline and store it in a physical device called a cold wallet, otherwise known as a hardware wallet or cold storage that is similar to a USB stick. While this protects from online attacks you risk losing your holdings for other reasons. As with any investment, do your due diligence and don’t pin all your hopes on any investment generating a return.
Spread your money around so you spread the risk and only invest what you can afford to lose.
Can I make money by investing in bitcoin?
Like any investment, making money depends on what price you buy and sell an asset for. If you sell when its price is higher than you bought it for, you will make money.
If you sell for a lower price than you bought it for, you will lose money.
For example, if you had invested in bitcoin at the start of:
2020 and sold on 31 December 2020, you would have made a 300% profit
2018 and sold on 31 December 2018, you would have made a 73% loss
Ways to invest in bitcoin
Buying the coins (or unit of a coin) on a cryptocurrency exchange is the most common way of investing in bitcoin.
But there are other options:
Buy shares in bitcoin-related companies
You could invest in cryptocurrency exchanges or even buy shares in companies that are accepting bitcoin as payment.
Bitcoin ETFs
You could invest in a bitcoin exchange traded fund ETF. This copies the price of the digital currency, allowing you to buy into the fund without actually trading bitcoin itself.
Invest in blockchain technology companies
You could invest in the blockchain network (the system for recording information about crypto). For example, tech platform Solana claims to be the fastest blockchain in the world.
Bitcoin funds
Several investment companies are launching bitcoin funds.
It will still be volatile, but it could be easier to sell your investment and get your money back than investing directly.
There are also funds that have some exposure to bitcoin as well as traditional assets like shares and bonds.
What are bitcoin options?
These are a form of financial derivative that gives you the right to buy or sell bitcoin at a set price (known as a strike price) before a certain date of expiry.
Unlike buying bitcoin cryptocurrency outright, bitcoin options enable you to take a speculative position (up or down) on the future direction of a market price.
You would buy a call option if you believe the market price would increase:
If your prediction was correct and the market price increased above the bitcoin option’s strike price, you’d be able to buy bitcoin at the pre-specified price. How far the bitcoin price rose past the strike price determines how much profit you’d make.
If your prediction was wrong and the price of bitcoin fell, you could let the options contract expire and only lose the premium you paid to open the trade.
Is bitcoin bad for the environment?
The digital currency uses as much power as the Netherlands every year, with just 30 countries using more energy, according to researchers from the University of Cambridge.
Computers that mine bitcoin use up to 1% of the world’s electricity supply.
While some of bitcoin’s consumption is renewable (an estimated 39%), fossil fuels are still being used to power the mining and servicing of the digital currency.
This is why electric car manufacturer Tesla stopped accepting crypto payments in May 2021, causing the price of bitcoin to fall at the time.
What are the fees when buying bitcoin?
If you want to buy and sell bitcoin, there are usually fees to pay, such as:
Transaction fees
Deposit fees
Withdrawal fees
Trading fees
Escrow fees
These usually cost a few percent of the total transaction value.
Do financial institutions support bitcoin?
Governments, regulators and companies are looking closely at bitcoin and other cryptocurrencies.
The Bank of England has been exploring the possibility of its own central bank-backed digital currencies. This has been dubbed as “britcoin”. Other central banks like the Federal Reserve have been doing the same.
As more institutional investors get on board with crypto assets for capital gains, this could help to calm dramatic price moves.
Why are regulators concerned about crypto?
The FCA has also warned investors to be wary about companies that promise high returns from cryptocurrency. The nature of investment means that there is never a guarantee of making money and a risk of loosing your capital.
In January 2021 the FCA banned the sale of complex derivatives that speculate on cryptocurrency movements.
This means that financial services can’t offer retail customers contracts for difference, spreadbet options, futures and exchange traded notes that focus on digital currencies.
What is Binance and can I still use it in the UK?
The UK financial watchdog has blacklisted cryptocurrency exchange Binance and banned it from carrying out any regulated activity over concerns about its money laundering controls.
The regulator has also ordered the company to stop any form of advertising in the UK.
Binance isn’t based in the UK, so the British regulator doesn’t have the power to stop crypto investors from buying and selling cryptocurrency using the exchange.
However, exchanges do have to register with the FCA to operate in the UK and are monitored for money-laundering.
This is a clear warning that investors should be very cautious about using the Binance exchange.
China’s crypto ban
Trading cryptocurrency in China has been illegal since 2019 in what Beijing said was an attempt to stop money-laundering. However, people can still trade online on foreign exchanges.
At the end of September 2021, China’s central bank went a step further by banning bitcoin transactions and effectively making cryptocurrency illegal.
The central bank warned that cryptocurrency “seriously endangers the safety of people’s assets”, which knocked thousands of dollars off the price of bitcoin.
Banks and payment firms are banned from providing cryptocurrency transaction services. In May 2021, three state-backed organisations announced there would be no protection for consumers if they lost any money from crypto trading.
The following month, banks and payment platforms were told to stop facilitating transactions while bans were issued on crypto “mining”.
Is cryptocurrency a good investment?
Cryptocurrency may be a good investment if you are willing to accept it is a high risk gamble which could pay off, but also that there is a strong chance you could lose all of your money.
Prices plunged in 2022, so if you are planning to invest in crypto, it’s important to go into it with your eyes open.
Cryptocurrency is an extremely high risk investment, so don’t invest unless you’re prepared to lose all the money. You are also unlikely to be protected if something goes wrong.
What are the risks of investing in cryptocurrency?
Governments and financial regulators in almost every country have warned investors of the risks posed by buying cryptocurrency.
And that the warnings have been so emphatic and widespread is partly down to the hype around digital currencies.
When an investment makes headlines for high returns, is featured in advertisements or endorsed by celebrities as a way to get rich, investors can pile in without thinking through the possible consequences.
1. Volatility Extreme volatility is a defining factor of cryptocurrency. While you may make high returns, you could also lose everything.
2. Scams In November 2021, around £1 million–worth of cryptocurrency scams were being reported to Santander UK by its customers each month. The scale of crypto fraud overall will be much greater.
One of the most common types is when a criminal hacks into your computer and freezes you out of your account.
3. Exaggerated promises of high returns Cryptocurrency firms may also be overstating how much investors could receive from investing in crypto, while minimising the risks.
4. No compensation scheme In the UK, deposits held with a regulated bank or building society are protected by the Financial Services Compensation Scheme. So if say, a bank or building society goes bust, compensation of up to £85,000 will be available to customers through the FSCS.
Crypto assets, however, are not regulated by the FCA, and so if the cryptocurrency exchange or platform where you have invested goes bust, it is unlikely that you will get your money back.
Is cryptocurrency a good way to make money?
Early investors in cryptocurrencies such as bitcoin will probably have made money. If you had spent £310 to buy one bitcoin in April 2016, six years later your investment would have been worth about £24,000.
But remember: past performance is not an indicator of future results. Bitcoin’s price soared through 2021, reaching record highs of $69,000 in November. But the price of bitcoin has been falling in 2022 amid a wider cryptocurrency sell-off as investors steer clear or riskier investments at a time of rising inflation and interest rates.
The price of a single bitcoin fell below $20,000 (£17,250) in June 2022. Since the start of 2023 it had been moving upwards and now sits at around $30,000.
The price fluctuations for even the most popular cryptocurrency highlight the extreme volatility of crypto investment.
Some new cryptocurrencies are intended to replace traditional currencies such as pounds or dollars. Others are used to create new types of financial application, or swap value between various digital currencies.
If you are considering buying into digital assets, look closely at projects individually to see how they might pan out in the future. But remember: investing in cryptocurrency is extremely risky and you should only invest what you can afford to lose.
Is there a “less” risky way of investing in crypto?
There are also some funds and investment trusts that have exposure to cryptocurrencies, which can be a less risky way of investing rather than buying the currencies themselves.
You could also buy shares in the companies associated with bitcoin.
“Stablecoins” could be a less risky way of investing in cryptocurrency, according to Gavin Brown, associate professor in financial technology at the University of Liverpool. However, the “stablecoin” TerraUSD did lose its dollar peg (a third of its value) in October of 2022 resulting in unpresented losses for investors and hit the rest of the crypto market.
Do I need to pay tax on bitcoin?
Almost one in ten British adults own a crypto asset, according to figures from HMRC.
But HMRC found that six in ten cryptocurrency investors weren’t aware of the tax implications around cryptocurrency.
When you sell a large amount of cryptocurrency you could be liable to pay capital gains tax (CGT). If your profits exceed the CGT threshold of £12,300 in a single tax year then you could be liable.
You also have to be wary of CGT when it comes to traditional investments like shares. Putting your investments inside a wrapper like an ISA or a pension could protect you from tax.