Cryptocurrencies possess all the characteristics needed to turn an investor into a speculator.

Investors find few things more alluring than the chance to get in on the ground floor of a new opportunity that promises to make them wealthy. They’re especially attracted by one that promises significant gains in a relatively short time with little or no risk. That was the appeal of the California gold rush of 1848 and the dot-com exuberance of the 1990s.

Just as many '90s-era tech investors couldn't explain why the price of their favorite software stock was going to the moon, few of today's investors in cryptocurrency-related offerings can't explain how cryptocurrencies work or why they are important. They just have a case of FOMO: Fear Of Missing Out.

Investment offerings tied to cryptocurrencies, or virtual currencies, have much the same effect on investors. (Note that we focus on securities offerings tied to digital assets, which the State Securities Board generally regulates, and not on the purchase of a particular virtual currency.)

The first and best-known of these, Bitcoin, was introduced in 2009. Today, there are hundreds of other virtual currencies—sometimes called altcoins, or alternatives to Bitcoin, such as Ether, Ripple, and Litecoin—which may use different business models, different formulas, and different distribution methods from Bitcoin.

Since reaching a market capitalization of $127 billion in less than a decade, it’s not surprising that Bitcoin, a cryptocurrency that may be used in place of actual currency, has stirred great interest as a speculative investment. Entrepreneurs have issued virtual currencies to raise billions of dollars in new capital to fund their start-up businesses. And several of the more popular digital currencies can be traded on exchanges, where they are valued in U.S. dollars or other world currencies.

Extensive hype, combined with investors’ lack of understanding, has made investments related to digital currencies particularly susceptible to fraud. The Texas State Securities Board in late 2017 conducted a comprehensive investigation of cryptocurrency offerings that revealed how pervasive these types of hoaxes have already become.

A second targeted regulatory "sweep" of cryptocurrency offerings is underway.

As an investor, you should look carefully at all aspects of cryptocurrencies before you commit any money to them. For example, be sure to examine their potential benefits as well as the dangers they pose. You should carefully assess all the risks, especially the chance that a virtual currency could quickly lose some or all of its value. And you might discover other concerns, such as taxes, that you’ll need to consider as well.

Remember one of the key principles of smart investing: Never invest in anything you don’t understand. It pays to begin with an understanding of cryptocurrencies, what they are, how they work, and the potential consequences of owning or investing in them.

Next up: The difference between a virtual currency and a fiat currency.

                                                                                                                                              

The Investor's Guide to Cryptocurrency Offerings was funded by a grant from the Investor Protection Trust and written in collaboration with Lightbulb Press