Bitcoin and other cryptocurrencies are receiving intense media coverage, prompting many investors to wonder whether these new types of electronic money deserve a place in their portfolios. Partner, Vanessa McElwrath, sat down with KVUE News to shed light on cryptocurrency and its merits as an investment [Video Below].
What is cryptocurrency?
As John Oliver cheekily put it, cryptocurrency is “everything you don’t understand about money combined with everything you don’t understand about computers.”
Unlike traditional money, no paper notes or metal coins are involved. No central bank issues the currency, and no regulator or nation-state stands behind it. Instead, cryptocurrencies are a form of code made by computers and stored in a digital wallet. Transactions are then recorded on a public ledger called blockchain.
What are investors to make of all this media attention? Is it a good investment?
Cryptocurrencies such as Bitcoin emerged only in the past decade. It has experienced dramatic price changes, sometimes gaining, or losing more than 40% in price in just a month or two. Recently, the value of bitcoin has risen sharply, but that is the past. A potential investor should consider its future value which is much harder to do relative to a traditional diversified portfolio consisting of stocks and bonds.
For example, when a company issues stock, it offers investors a residual claim on its future profits. When a company issues a bond, it offers investors a promised stream of interest payments and the repayment of principal when the bond matures. Bitcoin and other cryptocurrencies don’t actually produce anything, and there’s no income that comes from it. You’re essentially just betting that the value of it is going to go up. Like gambling, it’s a speculative investment and speculative investments tend to go up and down.
What are other issues to be wary of?
While Bitcoin and other cryptocurrencies may be virtual, they have very real-world tax consequences. If you fail to pay the tax you owe, you will be subject to interest and penalties and, in some circumstances, even criminal prosecution. The onus is on you the investor to understand what types of transactions give rise to taxes and to keep meticulous records and documentation.
It has also been the subject of increasing scrutiny by regulators. The US Securities and Exchange Commission (SEC) is taking a closer look because new and “cutting-edge” investments like cryptocurrencies have the potential to give rise to fraud and false “guarantees” of high investment returns.
Is there anything good that can come from the rise of cryptocurrencies?
None of this is to deny the exciting potential of the underlying blockchain technology that enables the trading of bitcoins. It is an open, distributed ledger that can record transactions efficiently and in a verifiable and permanent way, which has significant implications for banking and other industries which is yet to be fully realized.
But when it comes to investing and designing a portfolio, if it sounds too good to be true, it probably is. Get rich quick schemes don’t usually work. If you feel you just have to speculate, don’t do it with assets you need to accomplish important goals like emergency savings, retirement, or college funds. Limit any purchase with an amount of money that is not going to give you heartburn if it goes to zero.
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