Are cryptocurrencies too hot to handle for risk-taking youth?

By Roman Matkovskyy and Akanksha Jalan, Rennes School of Business

Cryptocurrencies are known for their potential for exceptionally high returns but also their unusually high volatility. And because of their unique risk-reward characteristic, they seem particularly attractive to young adults, many of whom seem to be addicted to them. This is not surprising, since young people are associated with greater risk-taking and aggressiveness in making financial decisions. This poses a major risk of financial loss for young adults, who may not have much money to start with.

Blockchain currency, or cryptocurrencies, represent a contemporary financial asset class that has attracted massive media and academic attention. The launch of bitcoin marked one of the most critical developments in modern monetary economics. The introduction of the first bitcoin futures contracts in 2017 paved the way for the development of cryptocurrency markets.

In general, the cryptocurrency industry includes cryptocurrencies, smart contract platforms, different types of 'coins' (including stablecoins and privacy coins), centralised and decentralised exchanges, exchange tokens, DeFi, derivatives, and Web3. Crypto assets have certain hedging and diversification characteristics. For example, the bull markets in the UK, Euro and Japanese bitcoin facilitate hedging against inflation by offering higher returns. Adding cryptocurrencies to traditional equity portfolios adds value in terms of enhanced returns. At the beginning of 2022 it is estimated that around 6.1% of the population currently own cryptocurrency and 19% of Brits have bought cryptocurrency in the past.

(Source: https://www.finder.com/uk/cryptocurrency-statistics). This highlights the popularity of crypto-currencies among UK investors.

Crypto-currency investing is on the rise

In July 2022, there were around 20,000 different cryptocurrencies traded with a global market capitalisation of $1tn (£892bn) (source: coinmarketcap.com). Despite having fallen by almost $3tn in the first half of November 2021, following huge price swings in crypto assets, venture investment in cryptocurrencies and blockchain continues to be strong. Statistics from CB Insights suggest that global funding was worth around $6.5 billion in Q2 2022 ($5.5 billion in Q2 2021). The main decline is in the US, with Europe showing an upward trend. In the UK, for instance, $400 million was invested in blockchain start-ups, a figure that has been increasing since Q4 2021 ($100m).

The appeal of cryptocurrencies to young people

The data suggests that cryptocurrencies are most popular with young adults. According to Finder's Cryptocurrency Adoption Index, nearly half of the world's crypto-currency owners are in the 18-34 age bracket. Furthermore, Pew Research shows that while income status does not appear to influence cryptocurrency use, gender does. One reason for this trend could be that young people are more likely to take financial risks; another reason could be the significantly lower cost of participating in these markets compared to traditional asset markets.

Cryptocurrencies: young people target high risks...

Despite the growing popularity of cryptocurrencies and their potential for high returns, they are considered one of the riskiest and most speculative assets today. Academic studies highlight the risky nature of this asset in the context of the general market downturn caused by the Covid-19 pandemic. While equity markets have shown greater potential to rebound to their pre-Covid levels even at higher levels of price shocks, cryptocurrencies have not only experienced a huge decline of over 50% but have also taken much longer to rebound to their pre-Covid levels. The results for stable, gold-backed currencies, which are considered safer than traditional crypto-currencies, highlight the fact that their volatility, and therefore associated risks, remain comparable to those of bitcoin.

Overall, the crypto-currency asset class, with its myriad of offerings, carries a high risk for investors in general and a still higher risk for impetuous younger investors who may not have a large amount of capital to start with, meaning they have a lesser ability to absorb price shocks.

Roman Matkovskyy is Associate Professor of Finance, Co-Director of the Financial Market and Corporate Outcomes Research Centre, Director of the MSc Financial Data Intelligence, at Rennes School of Business

Akanksha Jalan is Associate Professor of Finance, Director of the MSc in International Accounting, Management Control and Auditing, at Rennes School of Business