23 Oct 2017 15:57 IST

Bit of thrill, lot of risk

It’s best to exercise abundant caution while investing in virtual currencies

If you are one of the tech geeks who began mining bitcoins in 2008, you could be sitting on a fortune now, provided you managed to store these currencies safely in the digital wallets.

For this virtual currency, which was worth no more than the currency notes, used to buy swank properties world-wide in Monopoly, can now be exchanged for around $5,600 per unit.

Annual return delivered by bitcoins since they began trading in 2010 is more than 400 per cent. Late entrants who bought this virtual currency in January this year have seen the value of their investment gain 468 per cent.

It is, therefore, not surprising that many more Indians are in a rush to catch a piece of the action. Larger Indian Bitcoin exchanges such as Zebpay, Unocoin, Bitxoxo and Coinsecure are doing brisk business and are witnessing a surge in the number of traders on their platforms.

While the desire to make quick bucks in understandable, it would be best if investors understand the associated risks before jumping in.

“Investors should not invest in bitcoins just because prices are moving up. It’s their hard-earned money that they are putting into this, so they need to do their research and invest small amounts,” says Saurabh Agrawal Co-founder and CEO, Zebpay.com.

Investors should also be wary of some of the fixed-return products, designed around virtual currencies, that are in the market.

Déjà vu?

There are numerous virtual currencies traded across the globe, of which the most popular are Bitcoin, Etherium, Litecoin and Bitcoin cash. Bitcoin accounts for almost half the market capitalisation of virtual currencies.

But it needs to the noted that this is the second time in its brief history that there is a frenzy around bitcoin. This virtual currency was created by an anonymous person calling himself Satoshi Nakamoto in 2008. Active trading in bitcoin began in 2010 and up to the end of 2012, these currencies could be purchased for less than $15. It was in April 2013 that the price first scaled $100 and by December 2013, it was close to $1000, a ten-fold increase in few months.

Prices reversed after nudging $1,000 and the downfall in 2013 was led by crack-down on many bitcoin exchanges. The largest bitcoin exchange of them all, Mt Gox in Japan, shut down in 2014 when $450 million worth of bitcoins were reported stolen from the exchange.

Misuse of this currency for illegal cross-border transactions, including terror funding and drug trafficking, were other reasons that made bitcoin lose almost 80 per cent of its value by August 2015.

Understanding VCs

Similar frenzy is playing out this year too and a crash of similar dimension cannot be ruled out in the future.

The basic design of these currencies makes them prone to a high degree of price volatility. These currencies can be created by just about anyone who is tech savvy, by solving complex computer algorithms, through a process called mining.

Every bitcoin transaction is recorded in an open ledger called block-chain that can be accessed by everyone. The transparency and egalitarian nature of these currencies are their best features. That said, these currencies do not have sovereign guarantee like others.

There is no way to value the fundamental worth of these currencies, which paves the way for runaway rallies and steep crashes. With most exchanges trading virtual currencies being unregulated, you really have no recourse if an exchange goes under taking all your money with you.

The Reserve Bank of India has issued a couple of circulars warning investors about the risks of trading in these currencies. The Indian government is also taking a closer look at the operation of these exchanges to consider the manner of regulation. “We are requesting the government to allow us to form an SRO (self regulatory organisation) that will oversee the operations of bitcoin exchanges,” says Agrawal.

“It can be a watch-dog that will take care of the regulation. This will make sure that all the bad players get eliminated and good players get credibility. As far as consumers are concerned, they get the confidence that government is not discouraging their use and two, there will be consumer protection offered by the SRO.”

Beware of ponzis

Trading in bitcoin or other virtual currencies on various Indian exchanges is fairly straightforward. You have to open an account with a virtual currency exchange, their website or through a mobile app. The exchange does the KYC through documents such as Aadhar and PAN number. Those who wish to sell their currencies deposit the VC with the exchange; those wanting to buy have to first transfer the required sum into the exchange’s bank account.

Once the transaction is through, the exchange will transfer the VC to the buyer’s wallet and the funds to the seller’s bank account. A small fee is charged by exchanges based on the transaction value. Many workers in the IT sector and some HNIs are said to be dabbling in these instruments, mainly as a short-term investment. There are also reports of some entities offering fixed return products designed around virtual currencies. Investors are promised return at the rate of 1 per cent per day for 200 days if they purchase a certain virtual currency and lend it back to the platform. Some pyramid schemes are also purported to be offered to investors.

No one should fall for these schemes says Ashish Agarwal, founder Bitsachs, an exchange that is set to begin operations after Diwali. “Bitcoin has built a certain credibility and there are people trying to exploit this trust. These are basically ponzi schemes that should be avoided. As long as the revenue keeps flowing, the schemes will continue; when the revenue dries up, they will be shut down.”

There are other precautions that users need to take, such as using different passwords on different sites, not opening attachments from unknown persons, not entering user name and passwords on phishing websites, says Satvik Vishwanath, co-founder and CEO, Unocoin.

(The article first appeared in The Hindu BusinessLine.)