Is Bitcoin safe? What to know

Bitcoin and its cryptocurrency brethren have been making headlines for years now. Fortunes have been made – and quite often lost – by investing in cryptocurrency, and that may not change in the near future. Proponents of cryptocurrency see it as the currency of the future, coexisting with or even replacing government-issued currency, while critics believe that crypto has no future at all.

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Combined with the speculative passion with which traders buy and sell crypto, it’s no wonder that crypto prices are constantly engaged in a volatile tug-of-war.

Is Bitcoin safe?

Against this background, bitcoin is something of an “old guard”, as the first, oldest and by far the largest cryptocurrency. To some extent, this gives bitcoin an extra level of “security”, but that word must be used with caution. Bitcoin itself has many risks that make it anything but “safe” compared to more traditional investments such as bonds or even stocks.

Here are the most important aspects of investing in bitcoin that you need to know as an investor to help you determine how “safe” it can be in your portfolio.

Intrinsic value

Bitcoin is unique in the investment world in that it has no intrinsic value. Bitcoin was essentially created out of thin air, and it is not backed by earnings or profits – like the stock market – or the promise of a company or government that it would make payments – like a bond.

Even options and other derivatives, which technically have no pure value of their own, derive value from their connections to other securities.

Bitcoin’s value

Bitcoin, on the other hand, only has value because investors buy it in the belief that its price will rise in the future. There are many reasons behind this support, from the belief that crypto will be legitimized to pure speculative frenzy.

But as an investor, you have to realize that you will be buying an investment that has no intrinsic value to fall back on.

Volatility

You definitely need a strong stomach to invest in a cryptocurrency like bitcoin. Thanks to a number of factors, the price of bitcoin can fluctuate wildly. A look at the history of bitcoin’s annual returns only shows part of the story, but it’s still telling.

Price fluctuations

Since its inception in 2009, the smallest annual variation in bitcoin’s price was the 35% gain it posted in 2015. But bitcoin’s biggest annual gain was 2010, when it posted an astronomical 30,203%.

While that sounds like the kind of return any investor would want, you also need to factor in volatility on the downside. In three separate years, Bitcoin’s price fell by more than 60%, topped by the massive 73% loss in 2018.

Hype, speculation and promotion

More than any other asset class, cryptocurrency is subject to hype, speculation and marketing. Since cryptocurrencies like bitcoin have no intrinsic value, they can only increase in price when investors buy more in the belief that others will follow suit and it will go higher.

Entire message boards are devoted to hyping up cryptocurrencies like bitcoin, with rumors flying fast and furious. It can be difficult to determine which message posts or “news” are genuine and which are simply the work of speculators trying to manipulate the stock higher. This makes an investment in bitcoin inherently risky.

Tax

Many of the speculators who buy and sell bitcoin – or even those who use it for everyday transactions like buying coffee – may not be aware of the tax obligations associated with bitcoin.

Capital gains tax

From the investment side, the IRS considers bitcoin a capital asset, the same as a stock. In other words, when you buy and sell bitcoin, you’re responsible for reporting those transactions when you file for taxes—and you’ll owe taxes on any capital gains you generate.

Capital transactions

However, beyond buying and selling bitcoin as an investment, the IRS also considers using bitcoin to buy other goods as a taxable transaction. From the perspective of the IRS, when you use bitcoin to buy a cup of coffee, for example, you are converting your bitcoin into something else of value. Actually, technically you are exchanging bitcoin for dollars and then using those dollars to buy that cup of coffee.

If the value of your bitcoin at the time of the transaction is higher than it was when you bought it, it is a taxable capital transaction – the same as if you simply bought and sold your bitcoin on the open market.

Cyber ​​security

Cybersecurity is a serious issue when it comes to bitcoin, and it’s another type of risk that you need to understand as an investor. Since bitcoin is an intangible, digital asset, it must be stored electronically somewhere.

While there are different types of wallets and storage options for your bitcoin, at the end of the day, all digital assets and storage systems are vulnerable to cyber theft. While you can take steps to secure your bitcoin in the best way possible, cyber security can always be a concern.

Competition

All capital assets rely on the principles of supply and demand to derive their value. But since bitcoin has no tangible earnings or value behind it, if the hype and hope behind it dissipates, the price of bitcoin could plummet. What is one of the things that might pull buyers away from bitcoin? Competition.

Other cryptocurrencies

There are literally thousands of other cryptocurrencies, and new ones are constantly being created. While bitcoin remains the elephant in the room, if a developer creates an all-encompassing cryptocurrency that meets the demands, hopes and dreams of crypto buyers, it is possible that support for bitcoin will wane.

In that scenario, bitcoin might be relegated to a historical footnote, a “first mover” that started an industry but ultimately couldn’t keep up with recent developments.

How can you reduce the risk?

While there is no way to make bitcoin a completely safe investment, there are a few things you can do to reduce the risk to yourself.

• Keep bitcoin safe. A cold wallet, or hardware wallet, is the safest place to store crypto, followed by a warm wallet. Storing bitcoin on an exchange is the least secure option.
• Don’t invest too much. No matter how tempting it is to pour all your money into cryptocurrency when you hear stories of crypto millionaires, never invest more than you can afford to lose – because you just can.
• Avoid fraud. If it sounds too good to be true, it probably is. Make sure you do your research before investing.

The bottom line

This list of the risks of bitcoin is by no means complete. For example, many governments around the world are discussing creating their own digital coins, and some have even tossed around the idea of ​​making cryptocurrency illegal. Failure of crypto exchanges such as FTX is also a major risk.

But as an investor, you have to weigh all these dangers against the huge profit potential that cryptos like bitcoin have shown in the past. Whether these outsized gains will be available to investors in the future is unknown – that’s why there’s a market, after all – but it’s something to consider if you’re looking at owning or trading bitcoin.

Amber Barkley contributed reporting for this article.