In this post I wanted to explore some of the risks that people and businesses who invest in virtual assets face, and how this compares with what traditionally is thought more as physical assets. As the world moves more into the digital age, virtual assets are becoming more common and more popular, and with good reason. Understanding the risks is therefore very important.
Before I cover the 5 types of risks and how they apply, let's first make sure we all understand what are physical assets and what are virtual assets. Note that those lists aren't meant to be exhaustive.
Physical assets are things that you can hold in your hand, or see in the real world. Value is tied to that object. Here are some popular examples:
- Real estate - There's no question that for most people, their home will be their most valuable physical asset.
- Art - Even though the art world is concentrated at the top 1%, it's still a vast and very valuable class of assets.
- Antique cars - Car buffs that also manage to come into money tend to like collecting antique cars which hold their value well.
On the other end of the spectrum, virtual assets are things that hold value without being tied to a physical object. Here are some examples:
- Stocks - Even if you still hold a stock certificate, the value of company stock isn't tied to a physical object.
- Bonds - Similarly, you can hold bonds in an account and its value will be shown as digits on a screen, without forcing you to hold a physical object in your hands.
- Cryptocurrencies - Crypto like Bitcoin also holds a value without being tied to an object.
- NFTs - On the more speculative side, non-fungible tokens aim to place the value of an image or video on the actual digital representation rather than a framed photo.
- Game accounts or objects - While it may not seem like something of much value, people have sold World of Warcraft accounts on eBay for thousands of dollars. Similarly, some games and virtual worlds allow people to buy and sell in-game assets for real world cash.
Now that we defined what each type of asset is, let's go over the 5 most common risk types and see how they apply.
Loss of value
The first and perhaps most obvious risk category is a loss of value. This applies to both physical and virtual assets. While you may buy an investment property with the hope that it gains in value over time, you never know when a real estate crash is going to occur. Similarly, Bitcoin has shown clearly that it's able to go up and down in value wildly over time.
Theft or loss of the asset
Loss of the asset itself, whether it's by criminal means or because you simply lose it, can also apply to all asset classes. There are countless examples of criminal enterprises forcing people out of their homes, just like a valuable art piece may be lost in transport. Similarly, forgetting your password may make your cryptocurrency unrecoverable. Cyber criminals are also always on the look out for weak passwords. Again, this is a risk type that applies to both physical and virtual assets.
A slightly different type of loss, natural disasters is where things change. Fire, flooding, molding and so on is a constant problem for physical assets, but doesn't apply to virtual assets. A home may be covered by insurance, but there are many examples of 'acts of gods' not being covered. An art collection worth millions can quickly evaporate from mold or rodents if stored incorrectly. This isn't an issue with virtual assets since even if your home is a complete loss, your stocks will be safely stored in the cloud.
Depreciation of the asset is something that applies to all physical assets but does not apply to the digital world. A car will always depreciate over time, and even though real estate is renown to be an appreciating asset, that's only true because the historical rise in home prices tend to be higher than the depreciation of the asset. A 30 year old house will always look much more worn down than a brand new home, unless you spend a significant amount of money on upgrades. On the other hand, you can hold stocks in a company for 30 years and your stocks won't be any more worn down than the day you bought them. Same for crypto assets or NFTs.
Another common forgotten risk is the ongoing maintenance cost. When you buy a condo, you may need to take on a mortgage to pay the initial price, but there are many other costs you need to think about which won't go away once the mortgage is paid off. HOA fees, city taxes, water taxes, school taxes, regular maintenance, insurance, and so on. The same is true for smaller physical assets as well. Your art collection may need to be stored in a storage unit with monthly costs, or you may need to pay more for a bigger home, a security system, and so on. While it used to be the case that stock brokers charged ongoing maintenance fees, there are plenty of free options these days. You can also store your crypto or NFTs in a private wallet for decades, and not pay any ongoing fees.
As we've seen, out of the 5 types of risks, 2 of them apply to both assets types, however 3 of them only apply to physical assets. This doesn't meant virtual assets are always a better choice for any investment, and having a balanced portfolio is always wise. Any specific investment decision should only be made after you understand all the risks. But perhaps this is part of the reason why virtual assets have become more popular in recent years.