Cryptocurrencies: A Long-Term Investment Strategy?

Investing in cryptocurrencies has skyrocketed in popularity, especially during the pandemic. Crypto has delivered tremendous profits for some investors, while others have lost significant sums. It is important to understand that investing in crypto involves taking on a great deal of risk. Crypto assets are highly volatile, and there are numerous risks, such as wallet hacking, fraud, and cybersecurity threats. However, for investors who understand how to manage risk, crypto could present great opportunities.

If you are considering investing in cryptocurrencies, it is crucial to do your due diligence and understand the risks involved. It is also important to keep in mind that cryptocurrencies are not backed by anything, so the price is determined by the whims of traders.

Despite the risks, some investors view crypto as a good long-term investment. Widespread adoption and acceptance of cryptocurrencies could lead to an increase in value over time. Additionally, the growing interest in crypto from companies and governments could be seen as a positive sign for investors.

Overall, whether or not to invest in cryptocurrencies depends on your risk tolerance, investment goals, and time horizon. It is a speculative investment that may pay off in the long run, but there is also the potential to lose money.

Crypto volatility and risk

Cryptocurrency is an extremely volatile asset. Investors need to understand that crypto prices can fluctuate drastically due to their speculative nature, and investing in them involves taking on a great deal of risk. While crypto has delivered tremendous profits for some investors, others have lost significant sums. Therefore, it is crucial to understand the risks before investing in cryptocurrencies.

Loss of Capital

The volatile nature of cryptocurrencies means that investors could face significant losses if the market moves against them. With Bitcoin, for instance, experiencing a more than 60% decline over a 12-month period, these losses can be substantial.

Regulatory and Government Risks

The cryptocurrency market is subject to regulatory risks as governments and financial authorities around the world are still deciding how to treat these digital assets. The lack of clear regulations and the potential for governments to ban cryptocurrencies, as seen in China, creates uncertainty and risk for investors.

Fraud and Cybercrime

The cryptocurrency space has seen numerous instances of fraud and cybercrime, with hackers stealing billions of dollars worth of crypto. The lack of regulatory oversight in some cases makes it difficult to recover stolen funds, posing a significant risk to investors.

Cybersecurity and Storage

Cryptocurrency exchanges and wallets are vulnerable to hacking attempts and cyberattacks. Investors also face the risk of losing their private keys or login credentials, resulting in the loss of their crypto assets.

Volatility and Market Risk

The highly volatile nature of cryptocurrencies means that prices can be extremely unpredictable. This volatility is driven by market sentiment and speculation, making it challenging for investors to time their entries and exits.

Competition and Project Failure

The cryptocurrency space is highly competitive, with thousands of coins and tokens vying for market share. There is no guarantee that a particular crypto project will succeed, and many may turn out to be scams or fail to gain widespread adoption.

In conclusion, investing in cryptocurrencies carries significant risks and investors must carefully consider these factors before deciding to allocate their capital. While the potential for high returns is alluring, it is crucial to understand and manage these risks effectively to avoid potential financial losses.

Crypto vs stocks

The choice between investing in crypto or stocks depends on an individual's risk tolerance, financial goals, and understanding of each asset class. While stocks represent tried-and-true investments tied to real-world companies, cryptocurrencies offer new opportunities in a rapidly evolving digital landscape.

Ownership and Value

A stock represents fractional ownership of a company and its underlying assets and cash flow. The value of a stock is influenced by investor sentiment and the company's financial performance and growth prospects.

In contrast, cryptocurrencies, such as Bitcoin and Ethereum, are not typically backed by hard assets or cash flow. Their value is primarily driven by market speculation and demand-supply dynamics. The value of a cryptocurrency may increase if it gains wider adoption and is used in real-world transactions and applications.

Regulation and Governance

The stock market is highly regulated, with established exchanges such as the NYSE or LSE. Companies are required to disclose financial information regularly, and there are rules in place to protect investors.

Cryptocurrencies, on the other hand, lack a standardised global regulatory framework. Some countries are developing regulations, while others have banned them outright. The lack of regulation makes the crypto market riskier and less attractive to institutional investors.

Trading and Transactions

Both stocks and cryptocurrencies can be bought, sold, and traded on various platforms. However, crypto brokers often charge trading fees for each transaction, whereas many stock brokers have eliminated these fees.

Stock transactions are typically faster than crypto trades, which need to be approved and verified by the blockchain network. This process can take several minutes for Bitcoin and about 15 seconds for Ethereum.

Volatility and Risk

Cryptocurrencies are highly volatile and can fluctuate wildly due to speculative trading and investor sentiment. Stocks are generally less volatile and are influenced by corporate earnings and broader market trends.

While both assets carry risk, cryptocurrencies are considered riskier due to their high volatility, limited regulatory oversight, and their relative newness.

Potential for Returns

Cryptocurrencies offer the potential for substantial returns due to their volatility and newness. However, this also means there is a higher risk of losses.

Stocks have historically produced solid returns, with the S&P 500 returning about 10% over the long term. Stocks are considered a safer, less volatile investment option, especially when held as part of a diversified, long-term portfolio.

Suitability for Investors

The choice between crypto and stocks depends on an investor's goals, risk tolerance, and time horizon.

Stocks are generally suitable for investors seeking a safer, long-term investment option. They are also more accessible, with many online brokers offering low or no trading fees.

Cryptocurrencies are better suited to investors with a higher risk tolerance who are comfortable with the potential for significant gains and losses. Crypto may appeal to those seeking exposure to innovative technologies and decentralised finance.

Final Thoughts

Both stocks and cryptocurrencies have their pros and cons. Stocks provide a sense of security with regulatory oversight, potential dividends, and established market presence. Cryptocurrencies offer the allure of high returns, constant market access, and exposure to technological innovations.

As the financial landscape evolves, the divide between traditional and digital assets may blur. Investors should carefully consider their own circumstances and conduct thorough research before deciding whether to invest in crypto, stocks, or a combination of both.

Pros and cons of crypto investing

Pros

• Cryptocurrencies are supported by secure, decentralised blockchain technology, independent of traditional banking systems.
• Crypto markets are always open, allowing investors to generate returns outside of normal working hours.
• Cryptocurrencies are not tied to a single currency or economy, so their price reflects global demand.
• The number of coins is capped, preventing inflation.
• Cryptocurrencies have the potential to provide financial services to the unbanked and underbanked populations around the world, increasing financial inclusion.
• There is no fraud or scam risk in cryptocurrency investments. Unlike other payment methods, payments can never be declined, and there is no possibility of manipulation as it is secure and digital.
• There is no chance of personal information leakage. Cryptocurrency payments are 100% encrypted, and no one can access your private key or payment information.
• Transfer of ownership is immediate and secure. There are no fees or paperwork required, making it a more efficient process compared to property transfers or bank account closures.
• Cryptocurrencies are becoming more widely accepted by companies and governments, indicating a maturing industry and potentially safer investments.

Cons

• Cryptocurrencies often experience extreme price fluctuations and are therefore considered a highly volatile investment.
• There is a steep learning curve associated with cryptocurrencies, and it can be challenging to scale them widely.
• It is uncertain whether cryptocurrencies will remain viable in the long term, and there are security vulnerabilities that pose significant risks, especially to new investors.
• The regulatory landscape around cryptocurrencies is still evolving, creating uncertainty for investors and businesses.
• The loss of access to data and passwords can result in a complete loss of investment.
• There is a chance of performing illegal activities due to the high level of anonymity and security associated with cryptocurrency transactions.
• The risk of loss is high, as there is no ownership or authority over cryptocurrencies. If something goes wrong, there is no recourse or claim available.
• Storing cryptocurrency securely is challenging, and there is a risk of losing your private key or being hacked.
• There is no guarantee that a crypto project will succeed, as the market is highly competitive, and many projects are scams.

Crypto taxes

In the US, cryptocurrency is subject to income and capital gains tax. Your transactions are traceable, and the IRS has been working to track blockchain transactions.

You need to report crypto transactions to the IRS, whether or not they result in a taxable gain or loss. This includes documenting the fair market value of the assets in US dollars and calculating your capital gains or losses. You will need to fill out Form 8949, Sales and Other Dispositions of Capital Assets, to report capital gains and losses.

If you have other ordinary income related to crypto, such as staking or mining, you will need to use Form 1040 (Schedule 1), Additional Income and Adjustments to Income.

Crypto losses can lead to tax savings, as they can be used to offset capital gains and income for the year, and any additional losses can be rolled over to future tax years.

If you are earning crypto through your job, you will need to report this on Form 1040, U.S. Individual Income Tax Return. If you are an independent contractor, you will need to use Schedule C (Form 1040), Profit or Loss from Business (Sole Proprietorship).

If you are gifting crypto, you will need to file a gift tax return if you gift over $17,000 in crypto per recipient per year.

It is important to keep detailed records of all your crypto transactions and to consult with a tax professional for specific advice.

Crypto regulation

The regulatory landscape for cryptocurrencies is complex and varies across different countries and regions. Here is an overview of the regulatory approaches taken by some of the key jurisdictions:

• United States: In the US, the regulatory landscape is fragmented, with multiple agencies involved, including the Securities and Exchange Commission (SEC), the Chicago Mercantile Exchange, the Commodity Futures Trading Commission, and the Financial Industry Regulatory Authority. The SEC, in particular, has been active in regulating the crypto sector, bringing enforcement actions against crypto-centric businesses. However, the industry is pushing back, with Coinbase suing the SEC to force it to create new rules for digital assets.
• European Union: The EU has taken a more unified approach with the Markets in Crypto-Assets Regulation (MiCA), which aims to harmonize regulation across member states. MiCA focuses on consumer protection and market integrity, especially regarding stablecoins. The EU also has anti-money laundering directives in place, such as the 5AMLD and 6AMLD, which tighten reporting requirements.
• Switzerland: Switzerland is known for its clear and flexible regulatory framework, categorizing digital assets into payment tokens (e.g. Bitcoin), utility tokens, and security tokens. This clarity has made it a hub for blockchain startups, although traditional banks have been hesitant due to money laundering concerns.
• Japan: Japan was an early mover in crypto regulation after the Mt. Gox collapse in 2014. It has a dual regulatory system, with payment tokens regulated under the Payment Services Act and security tokens under the Financial Instruments and Exchange Act.
• China: China has taken a hard line against cryptocurrencies, banning crypto enterprises and Bitcoin mining in 2021.
• Canada: Canada has been proactive in crypto regulation, becoming the first country to approve a Bitcoin exchange-traded fund (ETF). It classifies crypto investment firms as money service businesses and treats cryptocurrency similarly to other commodities for tax purposes.
• Other countries: Countries like the UK, Australia, Singapore, and South Korea have also implemented various regulatory measures, including taxation, anti-money laundering requirements, and registration obligations for crypto exchanges and providers.

The regulatory landscape for cryptocurrencies is still evolving, and there are ongoing debates and legal challenges in many jurisdictions. As the industry continues to grow and gain mainstream adoption, clear and comprehensive regulations that protect consumers and foster innovation will become increasingly important.

Frequently asked questions