Cryptocurrency has taken the world by storm. Since 2009, when the first cryptocurrency—Bitcoin—was launched, the cryptosphere has seen tremendous highs and terrifying lows.
The truth is that cryptocurrency is an extremely volatile asset. Investors need to understand that owning crypto involves taking on a great deal of risk in their portfolios. But for investors who understand how to manage risk, crypto could present great opportunities.
Is It Safe to Invest in Crypto?
Crypto has delivered tremendous profits for some investors, while others have lost significant sums.
William Procasky, CFA, assistant professor of finance at Texas A&M University-Kingsville, says that new investors should stay away from crypto. But he also notes that more experienced investors, who understand how to cope with risk, could find a place for it in their portfolios.
“If you’re building a broad-based portfolio and want to add crypto to the 5% or 10% of your portfolio you’re setting aside for alternative assets, then you might be okay,” Procasky says.
Bitcoin and Ethereum are the two largest cryptocurrencies by market capitalization, and are more established than many other crypto options. This makes them a safer bet for most investors.
“If you go for options like Bitcoin and Ethereum, which are more mainstream, there’s a bit more safety around them,” says Lauren Niestradt, CFP/CFA, senior portfolio manager at Truepoint Wealth Counsel.
What the SEC Says About Cryptocurrency
The SEC has been skeptical of cryptocurrency. In an interview with Yahoo Finance, SEC chair Gary Gensler said that crypto companies need to “come into compliance” with existing laws.
These remarks came on the heels of the FTX debacle at the end of 2022.
Gensler’s hope is that, among other things, the SEC might offer consumers protection should crypto holding companies choose to become lending companies.
“There’s no reason to treat the crypto market differently just because different technology is used. We should be technology-neutral, Gensler said in an April 2022 speech.
This means not only new laws and regulations—which Congress is discussing—but existing regulations could affect how crypto exchanges and other companies do business.
Risks of Investing in Crypto
There are several risks associated with investing in cryptocurrency: loss of capital, government regulations, fraud and hacks.
- Loss of capital. Mark Hastings, partner at Quillon Law, warns that investors must tread carefully in crypto’s unique financial environment or risk significant losses. This is a risk with any investment, but crypto’s elevated volatility makes it an even bigger risk factor .With Bitcoin down more than 60% over the past 12 months, these losses could easily add up to a significant part of the original investment.
- Government regulations. According to Michael Collins, CFA, professor of financial planning at Endicott College, many governments have yet to fully regulate the use and trade of cryptocurrencies, which can make it difficult to know what to expect in terms of legal and financial risks. There are even some calling for cryptocurrencies to be illegal in the United States. This is probably an unlikely scenario, but since it has already happened in China, it’s certainly a possibility.
- Fraud. As with any unregulated industry, fraud abounds in the cryptosphere. Hastings says, “Cryptocurrency fraud soared in 2022, and the lack of regulatory oversight of the industry left many thousands of investors out of pocket.”
- Hacks. Hacks are quite common with crypto. According to Chainalysis, more than $3.2 billion of cryptocurrency was stolen in 2021. Although many exchanges offer private insurance, if you lose your crypto in a hack, you may have no recourse for getting back your investment.
The price of Bitcoin is around $17,000 as of this writing. This is significantly below its high of more than $65,000 in November 2021.
However, rather than a long-term investment, Bitcoin was initially lauded as a form of electronic cash. For this to work as promised, cryptocurrencies like Bitcoin would have to be able to be used to purchase goods and services.
But with more than 22,000 cryptocurrencies in circulation, very few of them are widely accepted for the purchase of goods or services.
In late 2020, it was estimated that approximately 2,300 U.S. businesses accepted cryptocurrency for payments. In 2019, there were more than 35 million businesses in the United States, which means those accepting cryptocurrencies are a drop in the bucket.
Could Crypto Become the New Global Currency?
With all the excitement around crypto, many backers have touted the prospect of it becoming a global currency.
“I don’t think governments will allow a competing currency like that on that scale,” says Procasky. “A global currency has to be very liquid and very deep, and there’s nothing that can compete with the U.S. dollar.”
Money is a tightly regulated and controlled asset. As was evident from the scandals of 2022—such as Terra Luna, Celsius and FTX—crypto can do significant damage to individuals’ finances in its current incarnation. The majority of the world’s governments would not allow their financial systems to carry that kind of risk.
“I think it’s years away,” Niestradt says, “and this is where some of the speculation lies. It’s not a certainty.”
Is Crypto a Hedge Against Inflation?
Those who still believe Bitcoin and other cryptos might be a hedge against inflation simply aren’t paying attention.
According to the U.S. Bureau of Labor Statistics, in Nov. 2022, core inflation was up more than 7% year-over-year. Bitcoin was down more than 65% over the same period.
“Crypto failed the test as an inflation hedge. If it’s possible to give it an F-, that’s how it performed,” says Procasky.
Cryptocurrencies and Taxes
Investors have to pay capital gains taxes on any income they’ve earned from cryptocurrency. This means virtually any time crypto changes hands, it becomes a taxable event, including mining or staking.
Capital gains taxes run around 15%, but they can be as high as 20% or more.
To make a purchase with cryptocurrency, investors usually have to convert it into fiat currency. This makes the use of cryptocurrency for most purchases taxable, which makes it more expensive than purchasing goods with cash.
Is Crypto a Good Long-Term Investment?
Widespread adoption would be necessary for cryptocurrency to gain long-term value, and crypto faces tremendous headwinds.
Andrew Rosen, CFP, president of Diversified LLC, says “While I think that the underlying technology of blockchain has innovation and practicality, until it is decoupled from the gamble of currency without regulation, it’s too risky.”
However, more speculative investors may want to take a chance on it.
These investors may or may not see a short-term payoff, but that’s not to say the right cryptocurrency wouldn’t be able to bring them tremendous profits over the long run. Of course, the total value of an investor’s cryptocurrency holdings could just as easily go to zero.
Should You Invest in Crypto?
The final determination about whether you should invest in crypto can only be answered by one person: you.
Whatever decision you make in that regard, however, it’s worth doing your due diligence, understanding each particular coin’s investment thesis and even talking with a financial advisor.
“There are other assets out there you can speculate in. It doesn’t have to be crypto, but if you believe long-term there’s a role for it and you believe in blockchain technology, then there’s a thesis for it,” says Procasky.