Investing involves deploying capital for expected positive returns, defined as profits exceeding the initial investment. This expectation carries "statistical significance," with risk and return typically being positively correlated. Traditional investment types include stocks (company ownership), bonds (debt obligations), funds (pooled investments like mutual funds and ETFs), and commodities (tangible assets and related financial instruments). Investing can be self-directed or professionally managed, with modern investing rooted in the 17th/18th-century establishment of stock exchanges.
Beyond traditional assets, alternative investments are used for portfolio diversification. Cryptocurrency is presented as a modern alternative, characterized as a decentralized digital currency operating on blockchain technology (Bitcoin being a prime example). It's used for investment and online transactions but is highly volatile and subject to rapid price fluctuations often driven by speculation. Services like Fidelity Crypto® and E*TRADE offer access, but stress the significant risk, including total loss, illiquidity, potential for market manipulation, and lack of regulatory protections like FDIC or SIPC insurance common to registered securities. Cryptocurrency ETFs offer indirect exposure without direct ownership, though the regulatory landscape is evolving.
Derivatives are financial contracts whose value is derived from an underlying asset (commodities, financial instruments, etc.). Key elements include an underlier, a future action, a predetermined price, and a future date. Derivatives are categorized as "lock" products (obligating parties, e.g., futures, swaps) and "option" products (giving the buyer a right but not obligation). Their primary uses are hedging risk, speculation for profit, leverage, creating option ability, obtaining exposure to otherwise untradable assets, switching asset allocations, avoiding taxes, and arbitrage. Common types include forwards (customizable, private contracts), futures (standardized, exchange-traded contracts), options (right but not obligation to buy/sell), and swaps (exchange of cash flows). More complex types like Credit Default Swaps (CDS) and Mortgage-Backed Securities (MBS), and Collateralized Debt Obligations (CDOs) were notably involved in recent financial crises.
Significant risks are associated with both derivatives and cryptocurrency. For derivatives, major risks include market risk (underlier value decline), hidden tail risk (unexpected changes in correlations during stress), leverage (amplifying losses), and counterparty risk (default by the other party), although some contracts are insured by clearing houses. The lack of transparency in over-the-counter (OTC) derivative markets has also been a regulatory concern. For cryptocurrency, consistent risks highlighted are high volatility, risk of total loss, illiquidity, potential for market manipulation, and the absence of regulatory protections afforded to registered securities. E*TRADE emphasizes that cryptocurrency value may be based solely on supply and demand rather than fundamentals.
