Should I invest in Bitcoin or other cryptocurrency?

About 145 million American adults say they own or have owned cryptocurrency. Statistically, more than half of your co-workers, neighbors and friends are.

It is also about the number of Americans who own shares.

Although not regulated by a government body, cryptocurrency is becoming mainstream. However, President Biden recently signed an order to address cryptocurrency risks with a holistic approach that could make cryptocurrency even more attractive to investors as well as traditional banks and credit unions.

In the short term, however, cryptocurrency remains a volatile, speculative asset that is likely to continue its gut-wrenching booms and busts. That’s not to say that cryptocurrency doesn’t belong in a well-diversified portfolio, but I recommend that my clients first educate themselves about cryptocurrency before deciding whether or not to invest.

As Warren Buffet said about investing in cryptocurrency: “I get into trouble enough with the things I think I know something about. Why on earth should I take a long or short position in something I don’t know about?”

Here are some important concepts to get comfortable with.

How Cryptocurrency Works: Basics

Let’s say you order a new set of patio furniture online. A credit card company or payment processor such as PayPal acts as an intermediary between you and the merchant.

But if you want to buy that patio set with cryptocurrency, there is no middleman. You carry out transactions directly with the seller. The cryptocurrency network assigns a public and a private key that becomes your unique address. You then use your private key to digitally sign the transaction.

There are no bank or third party fees. You store your cryptocurrency either in a “hot” or a “cold” digital wallet. You can get a software-based hot wallet from an exchange like Coinbase or a provider like Electrum or Mycelium. A cold wallet is a small, encrypted portable device from vendors such as Trezor and Ledger Nano.

What is Blockchain?

It is unclear which cryptocurrency names will survive, but the true value is likely to lie in the underlying blockchain technology. Originally created to power Bitcoin, the grandfather of cryptocurrencies, today there are thousands of blockchains for digital currencies such as Ethereum, Litecoin, Dogecoin, Tether and many others.

(As a side note, Dogecoin began as a joke in reference to the 2013 meme of a Shiba Innu named Doge.)

The blockchain uses a digital ledger to duplicate and distribute your patio furniture transaction to computers across the blockchain. Peer-to-peer computer networks verify and timestamp each transaction. Instead of a central authority such as a bank with associated costs and infrastructure, a network of users verifies the data.

The growing list of records, called blocks, are linked together using cryptography. Crypto mining verifies the next block on the blockchain. Miners are rewarded with cryptocurrency tokens plus any fees paid by the exchange parties.

Because the transaction is displayed across the entire network of computers on the blockchain, it is extremely difficult to change, hack or cheat the system. For countries with poor or corrupt financial institutions, blockchain-based cryptocurrencies protect against criminal activity. There is also an element of integrity since users can rate each other, and weed out unscrupulous users.

That doesn’t mean blockchain is completely hack-proof. Hypothetically, if a group of miners were able to take control of more than 51% of the blockchain’s mining hashrate or computing power, they could stop payments, reverse transactions, or duplicate coins.

Blockchain has a few negatives. All these computers and processes involved in cryptocurrency mining are energy hogs, making it environmentally friendly. Cambridge University found that Bitcoin mining takes more electricity annually than it takes to run Argentina.

And because blockchains require massive amounts of computing power over a distributed network, they are slower than centralized databases. The Bitcoin blockchain can only process 4.6 transactions per second, so it takes about 10 minutes to process a Bitcoin transaction. In contrast, the Visa network can process more than 1,700 transactions per second.

Blockchain is a transformative technology and has applications beyond cryptocurrency in healthcare, art, travel, legal, insurance and countless others. Consider any transaction that requires a central clearing authority, such as wire transfers or settlement trades.

Here are just three possible uses for blockchain:

• Real estate transactions have many moving parts and require verification with banks, title companies, attorneys and others. The blockchain can provide a secure, fast and affordable way to verify and register the purchase and sale of property.
• Since blockchain makes data breaches much less likely, it can be a secure method of storing personal data, such as social security numbers or dates of birth. And once the data is on the public blockchain, you can use it to vote, sign up for public benefits and share medical information with doctors.
• Cryptocurrency allows people to send money to other countries or to people without access to traditional banking services and without having to pay fees for a service like Western Union.

Watch out for: Tax matters

The IRS classifies crypto as a type of property rather than a currency. If you use digital currencies to buy or sell goods and services, you must pay taxes. Using cryptocurrency can leave you with an unexpected tax bill.

For example, the patio furniture seller who receives your Bitcoin as payment must pay tax on the current value. You may owe capital gains tax if the realized value of the sale transaction is greater than the price you paid for the cryptocurrency.

Buying crypto with cash and holding it is not a taxable event, but if you acquire digital currency from mining, you must pay tax on the value immediately. Getting paid in crypto also triggers tax liability. Transferring crypto from one digital wallet to another is not taxable, but converting from one cryptocurrency to another is.

Investing in crypto also has tax implications. If you sell crypto at a profit, you have to pay tax on the difference between what you bought it for and the selling price.

If this sounds like a lot of journaling – it is. The tax authorities require you to maintain records sufficient to establish the positions taken on tax returns. That means documenting receipts, sales, exchanges and the fair market value of your crypto assets. But unlike stocks, you don’t receive a Form 1099-B showing you the cost basis of the transaction. If you use cryptocurrency for day trading, transactions can amount to thousands.

The good news from a tax perspective is that it is possible to use tax loss harvesting to write off some losses. As stock losses, you can deduct up to $3,000 of crypto losses against ordinary income per tax year and carry losses beyond $3,000 until death.

Are Stablecoins Game Changers?

The value of cryptocurrency is largely driven by supply and demand. Unlike government-backed (fiat) currencies, where governments have the ability to print more money to increase supply, the majority of cryptocurrencies have published supply limits according to their token minting and burning schedule. There will only ever be 21 million Bitcoins. When demand exceeds supply, cryptocurrencies rise in value, sometimes dramatically.

Stablecoins aim to provide a less volatile type of cryptocurrency by tying the coin’s value to another currency, commodity or financial instrument. For example, the USDF Consortium, a membership-based association of FDIC-insured financial institutions, is trying to promote the introduction of a bank-branded tokenized deposit (USDF™) that is linked to the US dollar and will be insured up to $250,000 by the FDIC.

A stablecoin that turned out not to be stable at all rocked the market. TerraUSD, which relies on algorithmic coin supply management, lost its link to the US dollar and the Terra cryptocurrency lost 98% of its value in just 24 hours.

Protect your cryptocurrency

Unlike other assets that have built-in protection such as FDIC insurance, you are responsible for protecting crypto assets. You want to use two-factor authentication with a strong password and additional verification, such as fingerprint or facial recognition. Don’t buy crypto at the local coffee shop; use a secure internet connection.

Your digital key – a 256-bit long string of alphanumeric characters – is the only way to access your crypto assets. Hopefully you will never lose your private key. If you lose your key or throw away your cold wallet, your crypto is lost forever.

Seems unlikely? Tell that to James Howells, who accidentally threw an old hard drive in the trash, which was taken to the local landfill. He was never able to recover about $181 million in Bitcoin. Or Mark Frauenfelder, who wrote down the key to his hardware wallet on a piece of paper – which the cleaners threw in the bin. Or Stefan Thomas who would have over $100 in cryptocurrency if he could remember his password.

James, Mark and Stefan are not alone: ​​An analysis found that of the 18.9 million Bitcoins in circulation, 3.7 million have been lost by their owners.

If you die, your cryptocurrency is treated as a probable asset. However, because it is decentralized, beneficiaries may not be able to access it unless you include your cryptocurrency assets in your estate plan with instructions on how to access them.

Should you buy dips?

In 2009, when Satoshi Nakamoto (a pseudonym for an individual or group of individuals) released a white paper detailing Bitcoin, the coin had no value. In February 2011, it reached $1. A decade later, it reached $68,000. A few months after that, it lost half its value.

Many investors panicked and sold. Historically, a bear market is the best time to invest since you buy low with the hope of eventually selling the asset for more than you bought it for. Should you use the same strategy with cryptocurrency?

Possibly. But first, think long and hard about your risk tolerance. Do bear markets give you anxiety? Do you feel compelled to sell stocks and turn to the perceived safe haven of fixed income when economic news is bad? If yes, investing in cryptocurrency might not be right for you.

But if you’re willing to ride the highs and lows and already have a healthy emergency fund, have paid off all your high-interest debt, and are on track with your retirement savings and other financial goals, consider adding cryptocurrency as an alternative to a diversified portfolio.

If you’re interested in investing in cryptocurrencies or even the underlying blockchain technology and don’t want to invest directly, companies are starting to offer ETFs and mutual funds that offer exposure to companies involved in blockchain technology and cryptocurrency. This certainly makes it much easier to invest, but if the value skyrockets, you have to take part in the change.

Also understand that the SEC does not insure cryptocurrency against exchange errors or theft. Some exchanges offer insurance, but it does not protect against breaches or someone stealing your private key.

It can be easy to get caught up in crypto hype – especially when you hear about overnight millionaires and day traders making incredible profits – but the downturns can be excruciating. Just as you would with any speculative asset, set a maximum threshold for cryptocurrency in your portfolio – and stick to it.

Securities offered through Cetera Advisor Networks LLC, member FINRA / SIPC. Investment advisory services offered through CWM, LLC, an SEC-registered investment adviser. Cetera is under separate ownership from any other named entity. Carson Partners, a division of CWM, LLC, is a nationwide partnership of advisors. Address: 14600 Branch Street, Omaha, NE 68154.