With Facebook announcing the introduction of its new cryptocurrency, Libra, and Bitcoin’s price rising over $11,000 (as of this writing), we thought it’d be a good time to look at cryptocurrencies: what are they and should you invest in them?
First, a crash course in cryptocurrencies: a cryptocurrency is a “digital currency secured through cryptography, or codes that can’t be read without a key.” These currencies mostly rely on a technology called blockchain. Blockchain technology is a distributed ledger of all transactions that is unable to be altered in most circumstances. The distributed nature of blockchain means that no one entity, such as a central bank, can control the currency. For currencies such as Bitcoin, the supply of new coins is controlled by a process called mining. To mine Bitcoin, computers solve intense mathematical equations. By a wide margin, Bitcoin has the largest market share, with $195 billion compared to the total $329 billion of the over 2200 cryptocurrencies tracked by coinmarketcap.com.
SHOULD I INVEST IN BITCOIN?
If you’re going to wade into the world of Bitcoin, be very careful. Several Bitcoin mining companies have been charged by the SEC with being Ponzi schemes, fraud, and one Bitcoin exchange, Mt. Gox, declared bankruptcy after losing some 850,000 Bitcoin.
Bitcoin shares a trait associated with gold and other precious metals – it’s relatively rare. 21 million Bitcoin can be mined in total, and all Bitcoin production will cease by the year 2140. This can make Bitcoin both very valuable and very volatile. Historically, Bitcoin has been approximately six times as volatile as the S&P 500. As a result of this volatility, many people treat Bitcoin as a speculative investment.
In spite of these risks, a number of entities are moving forward with investment vehicles for cryptocurrencies. Several US fund companies have filed papers with the SEC to list Bitcoin ETFs, but so far none of these products have been approved. However, when these ETFs are introduced, they are expected to transform cryptocurrency markets. It’s expected to bring a flood of capital into the industry to help stabilize the volatile prices.
Additionally, an increasing number of people are investing in cryptocurrencies, primarily Bitcoin, through self-directed IRAs. Investing in Bitcoin through an IRA allows the investor to capture potential tax savings through the IRA. As a capital gains tax may be applied to all cryptocurrency trades, these savings may be substantial.
With these potential upsides come some significant risks. First of all, the firms offering self-directed IRA services aren’t bound by fiduciary duties, so investors are taking all of the risk on themselves when venturing into the crypto market. Also, there can be significant fees, from initial setup fees to custody and trading fees to annual maintenance fees. There can also be recurring custody and maintenance fees charged by these service providers.
Interested in cryptocurrencies? Wondering if they’re right for you? Get in touch with one of our Wealth Advisors and they’ll be happy to talk to you further on the subject.