What Wise Investors Should Know About Bitcoin

Over the last several years, cryptocurrency has seen a number of ups and downs in the market. Some investors have come away big winners from the crypto boom, but others have been less fortunate.

Lately there has been a renewed interest in Bitcoin and other cryptocurrencies following Donald Trump’s reelection. In the run-up to the election and since, Trump has talked much more about cryptocurrency than he or other presidents have in the past. At a recent cryptocurrency conference, CNBC quoted him as saying, “The U.S. is going to do big things with crypto.”

It’s uncertain what exactly that could mean in the long-term, but he has inferred that his administration will support cryptocurrency and that the government itself may buy and retain it. This apparent support has inspired a sudden spike in value since his election.

This has led to the obvious question any time we see a rapid increase in value: “Should I own this?”

With Bitcoin again in the news, you may have a lot of questions. How does cryptocurrency work? Is Bitcoin a good investment? Let’s review some of the frequent questions we hear so you can be better equipped to make wise decisions about your finances.

What Is Cryptocurrency?

Cryptocurrency is a deregulated form of currency that uses blockchain technology to track, store, and trade digital assets. Rather than dealing in bills or coins, the value is stored entirely electronically. Unlike regular, or “fiat” currency, it is not tied to any central government or bank. In some ways, it behaves both like a currency and like a stock.

It is currency in the sense of being a “a store of value” and a means to purchase items and services. You can exchange dollars for cryptocurrency in the same way you might exchange dollars for euros or pounds sterling.

It also functions as an investment because its value can fluctuate with supply and demand. A dollar you spend on cryptocurrency could balloon in value or deflate to nothing, depending on the overall amount of currency people invest in.

In some markets, where the native currency’s value fluctuates a great deal due to factors such as inflation or political instability, cryptocurrency may provide a more dependable alternative for storing value. However, the U.S. dollar remains one of the most stable currencies on the market. So, for American investors, cryptocurrencies are a much more volatile and speculative type of investment.

One of the oldest and best-known forms of cryptocurrency is Bitcoin, but there are many other crypto “coins,” each with their own value fluctuations.

What Should You Be Aware of Before Investing in Bitcoin?

Before making any major financial decision, it’s important to understand what you’re investing in. Here are a few things to keep in mind as you explore crypto investing:

Volatility

The most important thing to remember is that cryptocurrency is a highly speculative market. It is not uncommon for the value of an investment to increase fifty percent in a short period. However, it is also not uncommon for the value of an investment to drop fifty percent, either. We recommend only placing a small percentage of your wealth into highly speculative assets and maintaining a diversified portfolio.

 Deregulation

Part of the appeal of cryptocurrency is that it is deregulated, meaning it’s not attached to a specific government or entity. However, in order for a currency to be successful, there must be an element of trust. Not having the backing and regulation of a federal government can mean a lack of trust and therefore a lack of stability.

Prediction Challenges

Unlike most stocks, cryptocurrency is not tied to a particular corporation or product, so you can’t track probable changes by looking at an earnings report.

The value of cryptocurrency is determined entirely by supply and demand. When people want a particular coin, it drives up the demand, which increases the price. The more money is pumped in, the more the value rises. The factors that cause the rise and fall of cryptocurrency are still largely unpredictable.

Taxes

Currently all crypto gains are taxed at the capital gains rate. As with all investments, if you own the investment for under a year, you pay regular income tax on gains. If your crypto investment does very well, you may be in for a surprise at tax time. Sudden large capital gains can also affect state and medical benefits, and other things attached to your income.

Regulations

Government regulations are still catching up to the crypto marketplace. Rules that affect your investment may change frequently and drastically. We will do our best to keep you advised on this front, but politics are not always predictable.

Accessibility

While cryptocurrency is currency, it is still not spendable for most daily expenses. You will need to sell your coins to convert them to cash, and that conversion brings some added complexity. It is important to make sure you have cash on hand when it’s needed. 

Scams and Unknown Cryptocurrencies

If you follow the financial news, you’ve no doubt seen stories popping up about investors losing everything to crypto scams. It may be wise to stay with currencies that are well-established and trusted, like Bitcoin, and to treat new coins like investing in a high-risk start-up.

When to Invest in Bitcoin

Before you consider investing in cryptocurrency, it is wise to have your financial house in order. Start by building an emergency fund for short-term needs, managing debt wisely, and creating a retirement savings plan with 401(k) or IRA contributions. Have a plan for reaching your financial goals that is not wholly dependent on a sudden crypto boom. Only invest discretionary funds—money you can afford to lose—because you do not want fluctuations in the cryptocurrency markets to keep you from purchasing a house or beginning retirement.

If you’ve taken these cautionary steps and you still wish to invest, you have a few options:

1. Cryptocurrency can be purchased directly through companies like Coinbase by opening an account online.
2. You can store cryptocurrency offline in a “crypto wallet” which you can carry with you physically in a hard drive.
3. The SEC has approved certain exchange-traded funds (ETFs) that provide exposure to cryptocurrency through futures contracts, allowing managers to manage these investments on your behalf.

Our guidance for crypto remains largely the same as for any highly speculative investment: only invest a small portion of your worth, diversify, and invest according to your goals, not excitement about the newest trend.

Your financial advisor can help you with these steps, as well as help you get a realistic view of your risk tolerance, to build the investment plan that works best for you. You can reach out to an advisor at our Albuquerque or Arizona office with questions or to take the next step.

Disclosure: Cryptocurrency exchange-traded funds (ETFs) approved by the SEC provide exposure to cryptocurrencies through futures contracts and do not involve direct ownership of cryptocurrencies. These investments are highly speculative and carry significant risks, including volatility, tracking errors, and regulatory uncertainties.

Cryptocurrency ETFs may not be suitable for all investors. It is important to carefully evaluate your financial goals, risk tolerance, and investment horizon before considering such investments. Please consult with a qualified financial advisor before making any investment decisions. Past performance does not guarantee future results.