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Issues in Cryptocurrency Trading

Table of Contents

Introduction
Volatility
Taxation
Safety
Conclusion
References

Introduction

Ever since the success of Bitcoin, cryptocurrencies have been steadily growing in number as well as the volume of transactions that occur through them. Despite early assertions to the contrary, they have been found to be valuable tools for trading due to their variety of unique advantages.

As a result, governments and financial agencies are investigating cryptocurrencies and sometimes starting to add them to traditional stock exchanges. Investors are beginning to show an interest in them, as well, seeing the massive growth numbers and understanding that there is potential for cryptocurrencies to expand much more. However, adoption is still slow, both due to a lack of knowledge of how the technology works and the concerns that surround it. This essay will discuss cryptocurrency trading issues such as volatility, taxation, and safety, as well as business theories that can help one overcome them.

Volatility

Cryptocurrencies have gained a reputation for their instability, with Bitcoin, in particular, starting at $0, going up to $20,000 in 2017, dropping to $3,000 in 2019, and fluctuating between $5,000 and $13,000 since then. Their prices are highly sensitive to future projections and can change dramatically and unpredictably. As a result, investors can be cautious about going into the cryptocurrency market because of the risk that they may lose their entire investment. With that said, cryptocurrencies can also be characterized by extremely high yields, which makes them attractive to people who can afford to lose some money.

As such, they can be compared to volatile stocks, which attract many risk-takers who want to grow their capital rapidly. If one can enter and exit the market at the right times, they can benefit massively from such an investment. Financial planners should expect an interest in cryptocurrency to increase and understand the current state of the market as well as its likely future.

Mainly, cryptocurrencies operate similarly to many other stock market indices, with predictions of its future performance leading to corresponding price increases or drops. As Choi and Ozkan (2019) describe, mixed projections have led to changes up to 147% and -85% within a single day in the past. As such, a new approach is necessary to handle cryptocurrency, one that accommodates its frequent rises and falls.

People who intend to speculate on cryptocurrencies should study their behavior and learn to recognize long-term trends as opposed to momentary fluctuations. People who intend to make a long-term investment should view cryptocurrencies as a source of relative safety, similar to gold. Bitcoin, in particular, has a limited maximum supply of currency, meaning that it can be used as a hedge against inflation. However, the risk of a crisis of confidence always exists, and the investor should always be prepared to lose their money.

With that said, cryptocurrencies may become safer in the future, as market systems adapt to accommodate them. According to Cretien (2018), CFE and CME Group have bitcoin futures and are planning to expand the range of currencies that they cover, which may lead to future introductions of options and ETFs, as well. As the market embraces cryptocurrencies and institutional investors embrace them, they are likely to become less volatile and safer. They have a significant advantage over gold in the ease of their movement worldwide, though there is also the issue of their lack of intrinsic value as a material.

Overall, as cryptocurrencies are acknowledged as a viable hedge asset in the market, they are likely to become less volatile, though a degree of instability will likely remain. Still, anyone who is planning to trade them should be aware of the risk of losing their money through rapid devaluation and be attentive.

Taxation

One often-stated advantage of cryptocurrencies is that they are not tied to any nation, which enables them to be independent and used worldwide. Moreover, due to their relative novelty, many governments currently do not have systems in place to manage cryptocurrency exchanges. It is challenging to implement such frameworks because of the anonymity that serves as a critical factor for many currencies, with Bitcoin being the most prominent among them.

However, as cryptocurrencies become more prominent and represent a growing sector of the economy, work on measures that would affect cryptocurrency trading is probably going to intensify. The governments primary interest is likely to be in taxes, as the anonymity mentioned above can enable people to conduct large transactions and conceal their wealth. People and businesses that engage in cryptocurrency trading have to be aware of the current trends as well as what may happen in the future concerning the governments treatment of it.

It is challenging to tax cryptocurrency based on its converted value because of the constant fluctuations in this statistic. As such, governments have to employ measures that are more appropriate to other sources of taxation. Firth (2019) claims that the IRS advises taxpayers to treat what it calls virtual currencies as property, which means that each transaction that involves them has to be recorded in detail.

If one were to engage in many small transactions over a period, as would be the case if cryptocurrencies became more widespread as a medium of payment, taxation could become a severe issue with this model. As such, future developments will likely change this approach based on the success or failure of experimental models in other nations and the popularity of cryptocurrencies. However, at this time, people will have to deal with the current arrangements and the issues that they generate.

To facilitate the quick trading of cryptocurrency, many exchanges that match anonymous buyers and sellers or use a broker system have emerged. According to Firth (2019), many of them, especially popular and trusted ones, have instituted mechanisms for tax reporting that can help their users. However, these scenarios do not cover purchases made using cryptocurrency, as they take place directly without the need to use an exchange.

Instead, the receiver has to list them as income, determine fair market value, and pay their taxes based on the results of the conversion. The second step in this process can be convoluted, particularly in nations with weak cryptocurrency adoption and, thus, few or no exchanges that handle the conversion. With that said, methods may be different in those countries, and some have banned cryptocurrencies due to concerns such as money laundering. Overall, before engaging in trading, one should carefully review the laws of the country where they will be doing so and ensure that they are compliant at all times.

Safety

Cryptocurrency is still new, growing rapidly in both capitalization and diversity due to its popularity. Choi and Ozkan (2019) claim that there are at least 2,168 different cryptocurrencies and 17,779 exchanges available around the world, and the number is likely to have grown since the time of writing. Additionally, many people entrust their cryptocurrency wallets to a provider that guarantees the safety of their information while also simplifying its usage for trading.

All of these businesses are likely to have different levels of security, but, in general, theft is a concern because these companies have access to the wallet keys of all of their clients. A hacker that manages to enter the database of an exchange, in particular, could steal most of the currency that is being traded on it. As the amounts of money that moves around on a platform increases, it naturally becomes a more attractive target for potential criminals.

Unlike in the case of physical theft, defense mechanisms for the loss of cryptocurrency have not been developed yet. As Firth (2019) notes, most property and casualty insurers do not write policies that cover consumers from loss or theft of crypto assets (p. 29). Moreover, as the private key is the sole method of accessing ones wallet, its loss can render currency in that wallet permanently unrecoverable, harming the system as a whole.

Mühle, Grüner, Gayvoronskaya, and Meinel (2018) claim that up to a quarter of all bitcoins are permanently lost because their keys are no longer known to anyone. While it is possible to implement recovery procedures, one would have to make a new cryptocurrency to do so, as it would be nearly impossible to convince all of Bitcoins users to switch to the new format. As a result, while attempts to circumvent the vulnerability of physical key storage have been made, they are unlikely to challenge Bitcoins dominance soon.

To protect oneself from cyber theft, one should only use trusted exchanges, preferably large ones with no recorded history of attacks. Another option would be to secure ones key using offline encryption software that would require the physical presence of some token to unlock it.

However, this approach makes physical loss a concern if the unlocking item or the drive on which the information is stored are lost. There are online wallet providers that support recovery in case of loss, but, once again, they can be vulnerable to cybertheft. In general, awareness appears to be the only valid measure of protection against the potential dangers of cryptocurrency. Firth (2019) recommends researching the blockchain technology and learning how cryptocurrency works to obtain a better view of security. A person with a firm understanding of what the technology can and cannot do can take advantage of the numerous strengths of cryptocurrency while avoiding the weaknesses.

Conclusion

While cryptocurrencies hold vast potential for people and businesses worldwide, they are still in the early stage of their development and have prominent issues. Their value is unstable and prone to fluctuation, though these qualities are diminishing as a traditional market structure forms around them. Governments are concerned about the anonymity that cryptocurrencies provide and are developing taxation laws, but in their current state, they are highly complicated. Lastly, safety is a concern, both in terms of cybertheft and unrecoverable physical loss, though it can be minimized if one is aware of how they work. Overall, people and businesses that are planning to trade in cryptocurrencies should be aware of the concerns and prepared to handle them.

References

Choi, J. J., & Ozkan, B. (eds.). (2019). Disruptive innovation in business and finance in the digital world. Emerald Publishing.

Cretien, P. D. (2018). Crypto currencies: Price & pairs trading. Modern Trader, 543, 70-73.

Firth, R. (2019). Cryptocurrencies: Issues and best practices. Journal of Financial Planning, 32(4): 28-29.

Mühle, A., Grüner, A., Gayvoronskaya, T., & Meinel, C. (2018). A survey on essential components of a self-sovereign identity. Computer Science Review, 30, 80-86. Web.

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