Technology has transformed almost everything we do. So it only makes sense that it would change the way we pay for purchases. Cryptocurrency stands to innovate the financial market.
Of the cryptocurrencies now available, Bitcoin has made the biggest name for itself. Created in 2009, Bitcoin has continued to dominate the market, with promises of lower fees than other cryptocurrency options.
On the surface, it might sound like a great time to get in on this emerging trend. If you can buy at least one coin and hold onto it for a while, maybe it will increase in value. All you need to do is set up a wallet and start buying, after all. What could be easier?
Not so fast.
As with any investment, it’s important to take some time to research an asset before adding it to your portfolio. There are some things that make Bitcoin concerning to financial experts. Here’s what you need to know before you buy your first digital token.
It’s not a stock
Investing in Bitcoin is similar to investing in real estate or gold. You aren’t putting the money into stocks. You’re purchasing a digital coin, which you can then spend as you would using a credit card (although, not many retailers accept Bitcoin). So if you’re building your portfolio, this gives you one more asset to monitor.
There are some benefits to cryptocurrencies as an investment, though. You won’t have to worry about trading hours or regulations. But instead of your trades being monitored by a broker, your cryptocurrency transactions are logged in a ledger. That ledger is publicly accessible and, although your trades aren’t logged with your name or contact information, the transaction itself can be viewed by anyone.
Although cryptocurrencies aren’t stocks, there is something called an initial coin offering (ICO) that you can participate in as an investor. These are unregulated and not part of any stock exchange, but they give you a chance to support a cryptocurrency as it seeks to raise funds. ICOs are more crowdfunding events than IPOs, which serve as a company’s entry into the stock exchange.
It’s high risk
Whether you’re a new or seasoned investor, risk is not your friend.
Sure, you might want to put a couple of high-risk assets in your portfolio, but some investments are so risky they make even seasoned investors pause. Bitcoin is one of those investments.
If you look at Bitcoin’s pricing history, you can see that there have been drastic fluctuations. It has reached unprecedented highs in recent months, but there’s no guarantee it won’t drop rapidly.
In 2017, Bitcoin suffered a dramatic crash, losing one-third of its value in a single day. Investors have gotten confident as the cryptocurrency’s price has surged, but it’s important to remember the 2017 crash.
Its scarcity is a myth
One reason investors have rushed to invest in Bitcoin, driving its price up, is scarcity. They believe that there’s only a limited number of coins and, once they’ve all been mined, the value will shoot up.
There’s a reason for this myth. Bitcoin has a cap of 21 million, and currently, much of it has been mined. On the surface, it can seem like now is the time to get in. When the world reaches 21 million mined Bitcoins, they will increase in value due to scarcity, right?
There’s a problem with that line of thinking. Assets like gold and oil have finite resources. At some point in the future, there could be no more left to mine. Bitcoin, on the other hand, is a digital currency. The 21 million cap was set by a human. It’s possible that in the future, that decision could be overruled and more Bitcoin could be produced, which means it isn’t guaranteed to ever become scarce.
Investments are driven by emotion
Right now, Bitcoin appears to be the “it” investment. As the cost has skyrocketed, investors are jumping on the bandwagon. But these typically aren’t seasoned investors who tend to set aside intuition and feelings when it comes to building and managing a portfolio.
As a result, the price inflation is likely driven by word of mouth and good press. If something happens and Bitcoin tanks, those same individual investors will be quick to sell, leading to another crash.
While there’s nothing wrong with investing based on emotion, it becomes a problem when an asset is primarily backed by trend chasers. Instead of the steady, loyal investors, you might find with another type of investment, you’re seeing a large group of people who will be ready to cut bait at the first sign of trouble.
Bitcoin wallets aren’t hackproof
If you buy bitcoins, they’ll be stored in something called a digital wallet. Although wallets are built to be secure, that hasn’t stopped hackers from exploiting vulnerabilities to steal bitcoins.
Security experts advise keeping very little money in your online wallet, with most of it stored offline. If your wallet is hacked or stolen, the bitcoins on it will be lost forever. A secure bank vault can help protect you against loss.
Transaction fees cut into profits
Once you have bitcoins, getting them out of that wallet will cost you. In addition to the cost of the bitcoins themselves, you’ll also pay fees. There are transaction fees charged on every purchase. These include maker and taker fees, which can be as low as 0% or as high as 26%, depending on the nature of the trade.
One problem with Bitcoin transaction fees is that they go down significantly if you purchase higher volumes. That can encourage you to buy more cryptocurrency than you’re comfortable with. Worse, you may find the fees make smaller purchases less of a wise investment.
You’ll also pay transfer and withdrawal fees with some exchanges. Before you park your bitcoins, make sure you understand those fees. Coinbase, a popular Bitcoin exchange, charges no fees to store your cryptocurrency, but you will pay a fee for moving your bitcoins outside of the network.
Bitcoin is not the only cryptocurrency
Even if cryptocurrency replaces other forms of payment to become the preferred method, there’s no guarantee Bitcoin will lead the charge. In fact, competitors like Etereum and EOSIO have no upper limit, so they can be mined indefinitely. If you put your cryptocurrency eggs in the Bitcoin basket, it could be like investing in Yahoo or AOL in the early days of tech stocks.
One popular alternative to Bitcoin is Litecoin, which is an easier-to-use cryptocurrency. Ethereum has also become a serious competitor to Bitcoin. The bottom line is, are you sure that Bitcoin will be the top cryptocurrency a decade or two from now? How much are you willing to risk on that bet?
Perhaps most importantly, though – anyone can create a new cryptocurrency.
Granted, this is likely something that only a portion of the population would attempt, but that portion could be enough to flood the market with Bitcoin alternatives. That would, in effect, dilute the market, potentially making your own investment less valuable. If you’re counting on the laws of scarcity to make your bitcoins skyrocket in value someday, this is important to keep in mind. If Bitcoin is no longer available, would someone just create a similar alternative, or would a competitor instead take over the market?
A limited history
Yes, Bitcoin has been around for more than a decade. But when compared to other investment options, its history is quite short.
The 2017 crash is often cited as a reason the asset is a risk. But you can’t study its long-term performance to identify trends. The sudden crash in 2017 coincided with news of Bitcoin wallet cyberattacks. Although the price has had its fluctuations over the years, it’s hard to say how other events might impact the value.
Before investing in any asset, it’s important to take the time to conduct thorough research. There are apps that can help with that, but even those will be lacking when it comes to cryptocurrencies because there just isn’t enough history. You can’t pull earnings reports or balance sheets to learn what Bitcoin is saying about its own economic situation.
If you do decide to invest in Bitcoin, make sure you research it and competitors so that you’re making a fully informed decision.
You may not be able to trace cryptocurrency back over the decades, but there are precedents from other sectors. The stock market has seen many “bubbles” in the past, including the dot-com bubble in 2000. When a particular sector sees a huge surge, it’s only a matter of time before there’s a devastating drop, also known as the bubble bursting.
Experts have already expressed concern about the current thriving stock market. Even though they’re concerned, though, experienced investors continue to pour money into their portfolios. Still, even high-dollar investors have steered away from high-risk investments like cryptocurrencies.
It’s still the underdog
Cryptocurrency enthusiasts will tell you that someday digital currency will replace all others. But while plenty of people are eager to invest in it, it’s hardly poised to take over real-life wallets anytime soon.
Yes, the number of businesses that accept cryptocurrency as payment has increased. But it isn’t as easy as presenting an app on your smartphone. You’ll usually have to go through a third-party service to spend your bitcoins, and many consumers aren’t willing to jump through all the hoops.
Another issue holding Bitcoin back is the fact that investors aren’t spending it. They’re purchasing it and holding onto it. In fact, 60% of bitcoins are being held as long-term investments, with those owners having spent less than 25% of the bitcoins they’ve purchased.
Then there are the lost bitcoins. An estimated 20% of bitcoins haven’t moved from their address in the past five years or more. Lost bitcoins happen when owners can’t find their private keys or recovery phrase. Some may also be stored in the founder’s private stash. Lastly, there are some bitcoins that were deliberately sent to burn addresses to make a point.
Take lost and unused bitcoins out of the equation and what do you have? You have only 19% of bitcoins in regular circulation.
To really take over the world of payments, Bitcoin and other cryptocurrencies will need to cooperate with mobile payment solutions like Apple Pay and Google Pay. They may even have to forge a partnership with Visa or MasterCard. Consumers will also need to shift from thinking of Bitcoin as an investment to a payment method for it to truly replace cash or mobile wallets.
The truth is, as the “it” investment, Bitcoin is going to cost you. You’ll need thousands to buy one bitcoin. For many newer investors, it may not be a matter of whether the investment is too risky. They may struggle just to pull together $60,000 to put into one bitcoin.
Spending so much on each bitcoin also makes it tough to diversify. You may find your portfolio is more heavily weighted toward Bitcoin, especially if you’ve purchased multiple coins. This means that if there’s another crash, you won’t have the other assets necessary to offset your loss.
It complicates taxes
As with any financial transactions, your Bitcoin purchases and storage will need to be reported to the IRS. This can add yet one more thing to keep up with throughout the year.
To report your Bitcoin gains and losses, you’ll use Form 8949. If you sold any cryptocurrency during the year, you’ll report it here.
Cryptocurrency income will also have to be reported at tax time. You’ll need to include this on Form 1040 Schedule 1 along with the rest of your taxable income for the year. That means you’ll pay taxes on those earnings.
And speaking of the government, another issue with Bitcoin is that it’s anonymous (sort of). For Bitcoin to truly become a globally dominant currency, the government will likely want to have more of a hand in it. Staying anonymous as you move money through the ledger won’t be an option. The fact that it’s currently largely unregulated only adds to its riskiness.
Ultimately, only you can decide whether Bitcoin is a good investment. If you want to buy one or two tokens and try the technology out, it might be worth it.
As long as you’ve done your research and assessed the risk, as well as moderated that risk by diversifying your assets, you can sleep at night.