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Published On: Thu, Aug 11th, 2016

Crypto-currencies Survive Recent Volatility

The last four weeks have been a rollercoaster ride in the fledgling world of crypto-currencies. There have been two major hacks – one on each of the two most popular currencies, Bitcoin and Ethereum – a technical change in the way Bitcoin works, known as a halving, and no change in the underlying architecture of the blockchain, which many had hoped would be enforced by miners.

While this is all very technical for the lay person, it has highlighted a fundamental truth of sound personal financial management: diversification. While cryptos might not currently be appropriate for most private investors, there are a great many people that have made some sort of investment. These are incredibly high risk investments, to be sure, but not without merit.

Bitcoin Image/CASASCIUS

Bitcoin
Image/CASASCIUS

The question then becomes less about whether or not an investment is appropriate, or too high risk, but instead about what percentage of a person’s net worth is appropriate.

In this regard, Bitcoin and other alt coins are difficult to judge. For example, early investors in BTC have seen the price rise so strongly in recent years that they are almost certainly sitting on very substantial gains, and their holdings will probably be inappropriate for their financial circumstances. Your author, for example, has read comments on online discussion groups made by people that claim that 95% of their net worth is held in Bitcoin. If it works out for them, that will likely be a fantastic investment, but if it does not, then it will be the end of their finances!

This imbalance might be accidental however. Considering those huge price rises, some investors might have only risked a few hundred dollars and are now sat on a holding of tens or hundreds of thousands. If one investment has performed so well that it has made the rest of a portfolio unbalanced, it ought to be a very nice problem to have, and it might not be something that most investors would be inclined to remedy.

This is especially true given the range of positive factors that had been in the air only days before. Any price forecast for Bitcoin in recent weeks would have been very bullish.

That bullish case has not been delivered upon however. It has emerged that an important exchange in the ecosystem has been hacked and that around $60 million in Bitcoin has been stolen from Bitfinex. Bitfinex is one of the few platforms that makes it easy to actively trade on the price movements of BTC.

Just Like Forex Trading

For many people, trading on the price of Bitcoin is almost identical to the forex markets. Since Bitcoin is global and available constantly it is not easy for humans to monitor effectively. This means that just as with the foreign exchange markets, there are many automated solutions in use. Robo advisor programs have not caught on commercially to the extent that they have in forex, but this will change as the market develops. The prices of crypto currencies are generally quoted in US dollars because that is the global frame of reference that financial markets use, but they are also traded against the euro, sterling, yen and many more.

Such a substantial volume of trades in place at any one time means that if and when a platform is closed following a theft, there is a serious market dislocation. This is what happened and the price against the US dollar and other major currencies plunged.

While the general outlook for Bitcoin is very positive, especially when compared to the many economic factors that seem to be lining up against the global economy, the price is likely to remain volatile for the near future. Whether they are more or less volatile than the foreign exchange markets will remain to be seen.

Author: Stuart Langridge

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