Last month we saw the high-profile collapse of cryptocurrency lending and exchange platform, Bitconnect. The news that Bitconnect was shutting down came as a shock to many, but not to all.
As the platform collapsed, its associated token, Bitconnect Coin (BCC), plummeted from $400 in early 2018 to below $10, leading to significant losses for investors in the cryptocurrency.
BCC first gained traction last year, positioning itself as a rival to the likes of Bitcoin and Ethereum. Bitconnect customers could convert their Bitcoin to Bitconnect Coin (BCC) on the Bitconnect platform and receive interest payments from these tokens by loaning them out. The possibility of achieving significantly high returns in the process drew in investment.
Yet all was not as it seemed. A lack of transparency around the exchange itself and the token BCC has now caught up with Bitconnect. The exact events behind Bitconnect's collapse are still unclear. However, accusations that the company was essentially running a pyramid or Ponzi scheme are now in abundance.
The closure of Bitconnect's platform (and the resultant losses), contributed to an existential crisis for many crypto investors.
While the failure of one cryptocurrency doesn't threaten the long-term development of the entire market, the fall of BCC is a stark reminder to investors that they must do their due diligence before investing in an asset.
Whilst it is exciting to have the opportunity to participate in potential returns from the crypto market in its early stages of development, investors should pause for breath before making an investment decision on a particular cryptocurrency.
In short, the facets of investing associated with traditional asset classes still apply to investing in cryptocurrencies.
At eToro, we tend to compare investing in a cryptocurrency with investing in any start up. If you had the opportunity to invest in Apple, Amazon or Spotify way back when they were starting out, you would only do so if you believed in their potential to get their business plans off the ground and to scale. Cryptocurrencies are no different.
Crucially, investors need to take the time to understand the business model behind each cryptocurrency and decide for themselves if they feel confident backing this model. Or they should follow the investments of someone else with this expertise, just like you would invest via a fund manager.
Cryptocurrencies should not all be viewed as one and the same. Individuals will have different reasons for investing in Ethereum vs Litecoin vs Ripple, for example.
Key considerations when doing due diligence should include finding out who is behind the cryptocurrency where possible; potential use cases for the cryptocurrency and how other coins with similar use cases compare.
Investors can also mitigate risk by diversifying their portfolios. Short term volatility in cryptocurrency prices can present opportunities. However, for investors looking for a longer-term investment opportunity, diversifying across cryptocurrencies minimises exposure to volatility. Not only can investors diversify across cryptocurrencies but also across asset classes, again to shelter from price volatility.
A final consideration, which those affected by Bitconnect will know all too well, is the importance of researching the platform you choose to invest with before committing capital. It is important to know the location of a platform and how it is regulated (if at all) before committing to a cryptocurrency investment online. Whilst the cryptocurrency market itself is yet to be regulated, some exchanges and investment platforms will be regulated for products outside of cryptocurrency. This can be a small sign of comfort for investors on these platforms.
Bitconnect's collapse and the crash in BCC's price has no doubt spooked some crypto investors and added heat to the debate among crypto critics. However, those who are calling the end of the crypto market as a result have gone too far.
It is rare that investors are given the opportunity to participate in a market so early in its development. Cryptocurrencies remain an exciting investment opportunity as a result. But with this opportunity comes increased responsibility. The price dips in BCC last month act as a reminder that doing your research and spreading your risk is key.