From Volatility to Fraud, Is Investing in Cryptocurrency Just Too Risky?

In the wake of the 450% gain Bitcoin (CRYPTO: BTC) has logged since late 2022, it's not a stretch to suggest that plenty of investors are kicking themselves for not buying into (literally and figuratively) the cryptocurrency movement. Even without understanding what they're worth or how they're valued, clearly at least a few people are getting very, very rich off of digital currencies.

Just don't beat yourself up too much if you're one of the millions of people who missed out. You're hearing about the big wins, but you're not hearing about all the horror stories or the brewing risk.

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Unfortunately for some, it works just as intended

The crypto idea and underlying technology clearly have their merits. Most monetary transactions are already digitized in one form or another. Crypto's underlying blockchain -- a cryptocurrency's digital ledger that records and secures its own transfers -- just sidesteps the need for a centralized clearinghouse to facilitate these purchases. Such ledgers could theoretically even eliminate fraudulent transactions using conventional currency.

However, crypto's blockchain technology doesn't actually eliminate fraud. If anything, the nature of crypto makes it easier to swindle an unsuspecting person: There's no central clearing platform to vet and verify the legitimacy of both parties to a transaction. If nothing else, a bank or a credit card network can at least do that much.

And yes, plenty of people are being defrauded out of their crypto assets. As the Motley Fool's own in-house research arm reports, through the first three quarters of last year, scammers stole $1 billion worth of cryptocurrency from U.S. residents who believed their assets were safe from digital theft. As it turns out, the design of the blockchain works so well that there's no way to get a crypto holding back once it's been taken out of a digital wallet. Often, the recipient used a fake identity and is therefore impossible to track down.

This certainly doesn't bolster the argument that the world is better off by working around third-party payment intermediaries and central-bank-managed fiat currencies, even if most crypto owners are never scammed.

Perhaps the stronger argument against jumping on the cryptocurrency bandwagon, however, is its sheer unpredictability.

Being two things means it's not great at either

Sure, Bitcoin's extreme volatility since the beginning of 2023 has worked almost exclusively in its favor. And it's not the only one. Ethereum (CRYPTO: ETH) and XRP (CRYPTO: XRP) are also up big, along with a bunch of other digital currencies.

When asked exactly why they're willing to pay an ever-higher price for these cryptocurrencies, though, most buyers struggle to articulate an answer. They do offer responses, to be sure -- just not answers to questions like "Why is Bitcoin worth more than $90,000 right now?"

Few investors can specifically explain why Bitcoin might be worth more in the foreseeable future, either. Yes, it's an alternative to a U.S. dollar that is weakening in value. The country's central bank, however, can at least work toward stabilizing its value.

With any cryptocurrency, in contrast, its value is still entirely arbitrary -- only reflecting interested parties' perceptions at the time. There's no transparency or explanation regarding this valuation process.

Now connect the dots to spot the even-bigger overarching flaw here. That is, the very thing that makes Bitcoin such a compelling growth investment is also what makes it a lousy currency, and vice versa.

Think about it: Currencies of any kind are -- if nothing else -- supposed to be stable even if their underlying economies stumble and inflation means that money buys less. If a currency's value isn't at least somewhat predictable, it becomes difficult to use as a means of purchasing goods and services, undermining its utility and subsequent value. Simultaneously, it also becomes an undesirable means of pricing goods and services, perhaps aggravating an already-wobbly economy.

In this vein, the fact that Bitcoin and other cryptos are still priced in U.S. dollars only underscores the argument that they aren't actual currencies. For them to be the true value-storing currencies they're billed as, they would need to stand on their own as a pricing medium rather than always being expressed in U.S. dollars.

That said, one of the key tenets of investing in stocks (or bonds, or commodities, or any other asset) or simply sitting on a currency is scarcity. Assets have and retain value because they exist in limited supply, and the world needs and/or wants them.

That's not quite the case with cryptocurrencies. Although there is a finite limit to the number of Bitcoins that will ever be created, there is no limit to the number of other cryptocurrencies that can be digitally mined -- and potentially compete with Bitcoin. It's a problem simply because for any crypto to hold value, it must be the only usable currency within a particular marketplace.

The smartest alternative is still...

This is admittedly a complicated matter. That's part of the point. Complex premises are riskier simply because there are always nefarious actors that will leverage this complexity -- and your subsequent confusion -- to their advantage, and your disadvantage. Cryptocurrencies are no exception.

But what's the alternative? As volatile as the conventional stock market might be at times, it's not complicated. There is transparency, and oversight. There is real scarcity, and clarity. There's also a long history that more or less suggests what a stock should be worth right now, and what it could be worth in the future. Cryptocurrencies offer none of that in a measurable or meaningful way.

Should you invest $1,000 in Bitcoin right now?

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James Brumley has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Bitcoin, Ethereum, and XRP. The Motley Fool has a disclosure policy.