Although Bitcoin and other cryptocurrencies are becoming more and more popular, there are some important things you should know before investing in them.
Beyond understanding the fundamentals of cryptocurrencies, investors should be aware of the numerous risks associated with them, such as the fact that even the most well-known cryptocurrencies have experienced price fluctuations, that the market isn’t very transparent, that transactions are irreversible, that consumer protections are either nonexistent or extremely limited, and that regulators still haven’t made clear how they intend to regulate them. We advise investors who are interested in investing in cryptocurrencies to treat them as a speculative asset and use money that is not part of a conventional long-term portfolio.
Let’s examine some of the problems that surround them in more detail:
How does the SEC feel about cryptocurrencies?
Although current SEC Chair Gary Gensler has repeatedly stated that he has no intention of trying to outlaw them, the Securities and Exchange Commission has generally been skeptical of cryptocurrencies. Chairs have expressed concern that the product is too volatile, that investor protections are insufficient, and that regulations are insufficient. Over the past few years, the agency has turned down numerous requests for exchange-traded funds (ETFs) that make direct Bitcoin investments.
Gary Gensler, the chairman of the Securities and Exchange Commission, stated in August 2021 that he was open to the idea of cryptocurrency ETFs but not those that invested in spot markets because the futures markets are already governed by the Commodity Futures Trading Commission. The ProShares Bitcoin Strategy ETF (BITO) and the Valkyrie Bitcoin Strategy ETF (BTF), the first two Bitcoin futures ETFs, received approval and went live in October 2021. A few others have since followed, but they are all restricted to Bitcoin and Ethereum since those are the only two cryptocurrencies that currently have established active futures markets.
Will cryptocurrencies like Bitcoin replace fiat money as the standard unit of exchange?
We don’t believe so until there is appropriate regulation and consumer protections, but only time will tell. A currency typically needs three qualities to be functional:
It can be used as a cheap, trustworthy medium of exchange, a unit of account, a store of value, and legal tender that is accepted as payment.
It appears likely that Bitcoin’s use as a medium of exchange, a unit of account, or a store of value will be limited as long as it is subject to high volatility and high transaction fees. As cryptocurrencies have grown in popularity, the risk of regulation has increased, which eliminates some of their appeal to investors who see them as a currency not subject to central bank policy or national governments. This is another barrier to broader public acceptance of cryptocurrencies as a true currency.
Can Bitcoin be used as an inflation hedge?
Bitcoin’s value as an inflation hedge is speculative and unpredictable because it is currently not linked to the price of a basket of goods or services. Even though inflation data kept ticking higher throughout most of 2021 and 2022, Bitcoin saw both sharp price increases and declines. We still don’t know if Bitcoin will ultimately prove to be a reliable inflation hedge.
Which taxes apply to cryptocurrencies?
Currently, the IRS views Bitcoin as property rather than money. The IRS taxes cryptocurrency transactions whenever a taxable event takes place, such as when Bitcoin is exchanged for fiat money, used to pay for goods or services, or traded for another asset. Investors are currently in charge of keeping track of cost basis, gains, and other reporting. Consult a tax advisor or refer to IRS Notice 2014-21 for assistance.
However, beginning in 2023, cryptocurrency exchanges must report cryptocurrency transactions on form 1099-B under the Infrastructure Investment and Jobs Act of 2021 (IIJA), a law passed in November 2021. Starting in 2023, the IIJA will also mandate the IRS reporting of cryptocurrency exchanges involving $10,000 or more, similar to the current cash transaction reporting requirements under form 8300. It’s crucial to keep in mind that this $10,000 reporting threshold does not exempt cryptocurrency transactions under $10,000 from taxes. According to the tax code, even income that is not required to be reported to the IRS is taxable. For instance, even though the sale of $500 worth of goods at a flea market was not reported to the IRS on a Form 1099, the seller would still be responsible for paying taxes on that income.
