A Look at Cryptocurrencies

For those of you who have been unplugged from the world for the last couple of years, there has been a new entrant into the investing scene: Cryptocurrencies.  These have been around since 2009 when Bitcoin was introduced, but only have gotten a lot of hype and attention in the last couple of years since it has entered the mainstream.

In a nutshell, cryptocurrencies (crypto) are lines of code with perceived values.  Bitcoin was founded on the premise that we (humanity) will be moving away from fiat currencies, like the Dollar, Euro, and Yen.  It has had mixed results in becoming an accepted form of currency.  There are some places that will accept it, but there are issues with it being a form of currency.  The main place it has really caught on is in/on the dark web: That place that trades in less than legal commodities: drugs, illegal forms of pornography, illegal firearms and human trafficking to name a few. 

Why is it used so much for these types of dealings?  The main answer is that it is virtually untraceable.  This makes it extremely appetizing for money launderers.  You can legitimize a lot of funny money through using crypto.  This has caused it to come under the scrutiny of governments around the world.  The fact that it is not legal tender or backed by the U.S. government (or any other government) has made it rather confusing for governments to figure out how to regulate it.  At the moment, for the regular person who wants to “get into” crypto, it is as an investment, not something to just add to your bank account.  People are seeing other people get very rich off buying and selling crypto online and want to get a piece of that.

People using crypto as an investment need to be aware of some things.  One, it is not regulated, so there are scams galore associated with crypto.  It is also very difficult to track so as of now the IRS is relying on the honesty of US tax filers to report any gains (long and short term) they have using crypto.  It is treated like a capital asset, not a currency (www.irs.gov).  Many people do not report this, and as such are running afoul of the law.  The IRS is beginning to crack down on trading platforms to have them report transactions so they can properly tax them (via MarketWatch).

Another reason crypto isn’t widely used as currency is because of its volatility.  In layman’s terms, volatility is the capacity of a certain investment to have swings in its value over a short period of time.  Crypto is extremely volatile.  If a Bitcoin costs $50,000 at 8:00am and over the course of the day goes up to $58,000 and down to $45,000, that is volatility. 

A little story to illustrate the effects of volatility on Crypto

Let us say that Bitcoin is an accepted form of currency with this level of volatility.   Someone owns 50 Bitcoins, so at $50,000 they are worth $2.5 Million.  If it is as accepted as the United States Dollar, they can use it anywhere in the US.  So they decide to buy a big ticket item, like a $250,000 Lamborghini.  They go to the dealership and agree on terms and price of $250,000.  Well, this morning when they checked it, the Bitcoin they were paying with was worth $50,000 a piece so they agreed to pay 5 Bitcoin for the car.  Well, over the course of the negotiations the Bitcoin was having a high selling day and the value went down to $45,000 a piece.  Now they’re going to have to pay 5.5 Bitcoins for the car.  So they pay it and drive off.  By the time they get home, the value of the Bitcoin goes back up to $55,000.  This all can happen over the course of a couple hours.  As a currency, it is just not stable enough to justify. 

That is why many people are treating it like an investment.  They invest in crypto as they would securities issued by corporations or bonds issued by governments and corporations.  These are not regulated as securities though, so different (less in number and less refined) rules apply to them.  The Securities Exchange Commission is currently looking at crypto and working out a way to regulate it and bring it even more into the mainstream, but at the moment, it is still up in the air how that will happen. There are many people using it to diversify into a different asset class, albeit a very new and untested one.

As of now, when people ask me do I “do crypto”, my answer is not directly, but I can expose clients to that market with its ups and downs.  There are certain products (Exchange Traded Funds and Unit Investment Trusts) which hold crypto, its indices, or its underlying technology(blockchain) within them.  These ARE regulated products and do have rules mandated by the government.  Crypto, by itself, is not regulated and not available on my platform.  If someone really wants to get into it and start trading it, looking at regulated portfolios that hold it is a good place to start.  This is a much safer way to invest in this budding asset class without exposing oneself to undue risk.  That’s not to say these products won’t see volatility, because they will, but by being more diversified, by definition they are less risky.  There are many risks involved with buying cryptocurrencies:

1. Ownership issues:  If you buy crypto on a certain platform, make sure you can get the code and put it in a digital wallet that is stored locally on your device. It’s better to have the code for it yourself than allow others to dictate where it is.
2. That code mentioned above? It’s going to be long and complicated.  Write it down and store it somewhere you will not lose it.  Print it out and laminate it.  Password protect it.  Put that password somewhere else you will not lose it.  Do not assume you will remember it.  A story I like to tell is of the guy who has $30,000,000 worth of Bitcoin sitting in a password protected external hard drive.  He has 10 attempts to get the password right and after a 10^th failed attempt that drive gets wiped.  Poof, $30MM in assets gone like that.  He was on attempt 8 last time I heard.  Don’t be like that guy.
3. If you have it on someone else’s platform, like everything else online, it is vulnerable to hackers.  Not saying don’t do it, but just bear that in mind. 

I most definitely don’t have all the answers associated with this.  There are a lot of people out there who know bits and pieces of it as well, so take everything you hear about crypto with a grain of salt.  It is best to do your own research and figure out if investing in something this volatile is for you, because for some people, seeing 50-100% (or more) swings in values over the course of a few hours or a day isn’t something in which they want to be investing. 

Above all, be careful.  It is truly still the Wild West out there for crypto, but some companies are starting to get on board with it. Some people have made a lot of money but many more have lost value and or money on it.  Best advice I can give is just do your homework on it.  If you have any questions for me, let me know, but I will preface that with I really don’t know everything about it, but if you ask, I will research it if I don’t know the answer.

Be Happy, Be Well, and most importantly, Be Kind.

Brian