2017 was a great year for Indian equity investors, but one investment that put these returns in the shade and had investors nursing a missed out feeling was the bitcoin and its many cryptocurrency cousins. Bitcoin prices (source: Coindesk) shot up from the $970 mark at the beginning of 2017 to $12,630 by December, a cool 1,200 per cent return in one year. While this had cryptocurrency fans partying, conventional investors were gnashing their teeth.
So, should you be allocating a part of your portfolio to this new asset class? Well, if you are considering it, take note of its risks. One, while bitcoin's returns beat equity funds hands down, it is a much more volatile investment than the Sensex. Over the last five years, the maximum loss made by the BSE Sensex on any given day was about 6 per cent and its biggest single day gain was about 4 per cent. But the bitcoin, on its bad days, proved five times as volatile as the Sensex. Also, 10 per cent blips in a day were not unusual for the bitcoin, with 36 such occasions in the last five years.
Two, one of the key attractions of cryptocurrencies for global investors is the fact that they're not controlled by governments or central banks, which have steadily debased paper currencies in recent years. But as trading volumes of cryptocurrencies have climbed up lately, regulators across the world are taking a closer look at them. The Chinese government, in August/September 2017, banned initial coin offerings and cracked down on the exchanges trading bitcoin. The Australian and Japanese governments, on the other hand, have moved to register and regulate cryptocurrency exchanges.
In India, the RBI has issued three warnings to the users of virtual currencies and the finance ministry has recently added to this chorus, warning that cryptocurrencies are not legal tender and that users dealing in them are doing so at 'their own risk.' But even as an RBI-appointed committee mulls the way forward, the big bucks made by cryptocurrency investors have caught the eye of the Indian taxman. In mid-December, the Income Tax Department was said to have initiated a probe into the four-five lakh high net worth individuals who were registered on the cryptocurrency exchanges and has indicated that the capital gains made on cryptocurrency trading would be liable for capital gains tax. The Enforcement Directorate is also said to be investigating instances of FEMA violations by cryptocurrency users.
But while bitcoin bets appear risky at this stage, it is clear that some parts of the cryptocurrency ecosystem will revolutionise the financial world. The distributed ledger 'blockchain' - the technology which underpins the bitcoin - has applications in a wide variety of sectors, from banking and financial services to e-governance. As we write this, many global banks have acquired blockchain start-ups and even governments are taking a hard look at how to adopt blockchain. So, do keep your eyes peeled for any conventional investment opportunities that allow you to piggyback on the promise of blockchain.
What to do: Given the Modi government's keenness to plug money laundering, the cryptocurrency ecosystem is likely to attract some form of regulation very soon. KYC and regulations of the money laundering act may be brought in at the very least. So, if you are a law abiding citizen who has stuck to financial assets so far, you should wait for these basic rules to be put in place before dabbling in bitcoins.