Crypto Fund Investment: A Smart Move?

Investing in cryptocurrency is risky, but it can be lucrative. Cryptocurrency is a digital currency that can be used to buy goods and services or traded for a profit. Bitcoin is the most widely used cryptocurrency. It is also the longest-standing and most secure cryptocurrency, with a market cap of over $1 trillion as of mid-October 2021. Cryptocurrency investing can take many forms, from buying cryptocurrency directly to investing in crypto funds and companies. Crypto funds, such as crypto ETFs and crypto mutual funds, offer investors a convenient and diversified way to invest in cryptocurrencies. However, it is important to note that investing in cryptocurrency is risky, and there are tax consequences to buying and selling cryptocurrencies.

Crypto exchange and wallet options

There are several options for crypto exchange and wallet providers, each with its own advantages and disadvantages. Here is a detailed overview of some of the popular choices:

Crypto Exchanges

• Kraken: Kraken is a well-reputed cryptocurrency exchange that offers a large number of supported cryptocurrencies and advanced order types. It is suitable for experienced traders and has low fees.
• Coinbase: Coinbase is a beginner-friendly platform with an easy-to-use interface. It offers a wide range of cryptocurrencies and strong security features.
• Crypto.com: Crypto.com provides a vast ecosystem, supporting over 350 cryptocurrencies. It has a highly-rated mobile app that offers a wide range of features and products.
• Gemini: Gemini is known for its robust security protocols and is SOC 2-certified. It offers a professional-grade trading dashboard and supports over 80 digital currencies and tokens.
• BitMart: BitMart is ideal for those looking to trade a wide range of lesser-known cryptocurrencies, as it supports over 1,500 digital currencies and tokens. However, it has received some negative customer feedback regarding withdrawal problems and poor customer support.
• Cash App: Cash App allows users to seamlessly buy, sell, and store Bitcoin from their smartphones. It also supports the Bitcoin Lightning Network for near-instant transfers.
• Bisq: Bisq is a decentralised exchange that allows users to buy and sell Bitcoin and other cryptocurrencies without the need for Know Your Customer (KYC) identity verification. It offers a high degree of privacy but may not be suitable for beginners due to its complex peer-to-peer trading process.

Crypto Wallets

• Hot Wallets: Hot wallets are connected to the internet and are often free to use. They offer convenient add-on services such as trading or staking but may be more vulnerable to hackers. Examples include Crypto.com DeFi Wallet, Zengo, and Guarda.
• Cold Wallets: Cold wallets are hardware devices that are not connected to the internet, providing an extra layer of security. They tend to cost money and can be more challenging to set up and use. Examples include Ledger and Trezor.

Crypto investment risks

Investing in cryptocurrencies is risky. Here are some of the main risks associated with investing in crypto funds:

Volatility

The prices of cryptocurrencies are highly volatile, more so than other asset classes like stocks. This volatility is driven primarily by supply and demand, not inherent value. Cryptocurrencies are a young currency and market, and it is not uncommon for the value of cryptocurrencies to quickly drop by hundreds or thousands of dollars within a day or even minutes. This makes crypto investments high-risk and speculative.

Regulatory Risk

Cryptocurrencies are currently unregulated by governments and central banks, and there is no regulatory infrastructure in place. This lack of regulation means there is less investor protection, increasing the risk of fraud and manipulation. Additionally, there is a risk that certain countries may restrict the right to acquire, own, hold, sell or use cryptocurrencies in the future.

Cyber Security Risks

Cryptocurrency trading platforms and third-party service providers may be vulnerable to hacking or other malicious activities, such as phishing attacks. There is also a risk of technical glitches and human error. If the private key to a digital wallet is lost, destroyed, or compromised, investors may be unable to access their cryptocurrencies, resulting in a financial loss.

Lack of Recoverability

Cryptocurrency assets are accessed using a key. If this key is lost or if access to the storage location of the key is lost, the investor will lose possession of their cryptocurrency.

Forks or Discontinuation

Cryptocurrency trading carries additional risks, such as hard forks or discontinuation of the blockchain. Forks can cause substantial price volatility, and discontinuation of a blockchain could result in a total loss of investment.

Tax Implications

There is uncertainty regarding the tax treatment of investments in cryptocurrencies. Investors may be subject to sales or value-added taxes on purchases and sales of digital currencies, and it is the investor's responsibility to track cost basis, gains, and other reporting requirements.

Network Slow-Down

A high volume of transactions on a blockchain can cause a slow-down, impacting the ability to validate transactions and potentially leading to a decrease in pricing and trading volume.

Dilution Due to Competition

The creation of new cryptocurrencies or "forks" in the blockchain can result in competition and dilution, impacting the value of existing cryptocurrencies.

Crypto investment rewards

Investing in cryptocurrency is risky, but it can also be rewarding. Here are some of the potential rewards of investing in crypto:

Diversification

Some investors believe that the lack of correlation between cryptocurrency and other asset classes could mean that crypto adds diversification to an investment portfolio.

High Returns

The crypto market is known for large price movements. Cryptocurrencies like Bitcoin have seen intense volatility, with prices ranging from $17,000 in early 2023 to a 52-week high of over $73,000 in March 2024. This means that while there is a high risk of loss, there is also the potential for high returns.

Passive Income

Staking is a way to generate passive income from crypto holdings. By locking up their crypto to help run the blockchains that support certain cryptocurrencies, investors can earn rewards. Annual Percentage Yields (APY) can be as high as 6% for certain cryptocurrencies.

Tax Advantages

Investing in a cryptocurrency Roth IRA can provide tax advantages. Additionally, retirement accounts like IRAs and 401(k)s can be used to invest in crypto mutual funds, which is not possible when buying Bitcoin directly.

Accessibility

Cryptocurrency can be bought and sold at any time, providing 24/7 access. Additionally, there are now many ways to gain exposure to the crypto market, including crypto-focused mutual funds, ETFs, and companies.

Crypto funds and companies

Investing in cryptocurrency can take many forms, from direct investment in crypto coins to investing in crypto funds and companies. Crypto funds and companies are an increasingly popular way to gain exposure to the crypto market, offering a more diverse and convenient investment strategy.

Crypto Funds

Crypto funds are a way to invest in a collection of crypto assets, packaged together as a single investment. These funds are professionally managed and may include various cryptocurrencies, crypto-related assets, and companies that service the crypto market. Some examples of crypto funds include:

• Cryptocurrency Mutual Funds: These funds are similar to traditional mutual funds, investing in a variety of crypto assets to provide a diverse portfolio for investors. The US currently has only one such fund, the Bitcoin Strategy ProFund, which invests in Bitcoin futures.
• Cryptocurrency Exchange-Traded Funds (ETFs): ETFs pool investor funds and invest in a collection of assets, similar to mutual funds. The main difference is in pricing and trading. ETFs have share prices that fluctuate throughout the trading day, while mutual funds are priced once per trading day. Examples of crypto ETFs include the ProShare Bitcoin Strategy ETF and the Valkyrie Bitcoin Strategy ETF.
• Cryptocurrency Trusts: These are investment trusts that focus specifically on cryptocurrencies. They allow investors to take a more hands-off approach, with companies like Grayscale offering trusts that track the performance of Bitcoin, Ethereum, and other large cryptocurrencies.
• Hedge Funds and Venture Capital: There are also numerous hedge funds and venture capital firms that invest specifically in crypto and blockchain-related projects. These include Pantera Capital, Andreessen Horowitz, Paradigm, and Coinbase Ventures, among others.

Crypto Companies

Investing in crypto companies involves putting money into businesses that are focused on the cryptocurrency market and blockchain technology. This can include a range of companies, from crypto mining companies to those that support cryptocurrency transactions. Some examples of crypto companies to invest in include:

• Robinhood Markets Inc. (HOOD) and PayPal Holdings Inc. (PYPL): These companies are well-known for supporting cryptocurrency transactions and offering crypto-related services.
• MicroStrategy Inc. (MSTR): This company holds large amounts of cryptocurrency on its balance sheets, making it an attractive investment for those interested in the crypto market.
• Crypto Mining Companies: Investing in companies that mine cryptocurrencies, such as Genesis Block Capital and Genesis Block Holdings, can provide exposure to the crypto market.
• Blockchain Technology Companies: Investing in companies focused on blockchain technology, such as those offered by the Schwab Crypto Thematic ETF, can also provide indirect exposure to the crypto market.

Things to Consider

When investing in crypto funds and companies, it is important to consider the risks and volatility associated with the cryptocurrency market. The prices of cryptocurrencies can be highly volatile, and regulatory changes could significantly impact the value of these investments. Additionally, it is crucial to research the fees and expense ratios associated with different funds, as these can impact your overall returns. Diversification is also key, as investing in multiple funds or companies can help reduce the risk of losing money in a highly unpredictable market.

Crypto regulation and taxes

Investing in cryptocurrency is risky, and the volatile nature of the market means that regulatory changes could significantly impact the value of your investment. For example, if cryptocurrency became illegal, it would immediately become worthless.

In the US, the Securities and Exchange Commission (SEC) regulates the market, and has rejected many crypto funds over the years, citing the potential for fraud, volatility, and lack of investor protection. The SEC has indicated it would be more receptive to futures-based crypto funds, and several Bitcoin ETFs were approved towards the end of 2021.

The regulatory landscape is constantly changing, and in August 2023, the Biden administration proposed new crypto tax-reporting rules. The rules would require cryptocurrency brokers, including exchanges and payment processors, to report information on users' sales and exchanges of digital assets to the Internal Revenue Service (IRS). This would include both centralized and decentralized digital asset trading platforms, crypto payment processors, and certain online wallets. The proposal is designed to help taxpayers determine if they owe taxes and would subject digital asset brokers to the same information-reporting rules as brokers for other financial instruments, such as bonds and stocks.

The new rules are part of a broader push by Congress and regulatory authorities to crack down on crypto users who may be failing to pay their taxes. The IRS currently requires crypto users to report many digital asset activities on their tax returns, including trading cryptocurrencies, regardless of whether a gain was made. It is important to note that the IRS treats cryptocurrency as property, not currency, and transactions in cryptocurrency spot markets are thus considered taxable.

The proposed rules are not yet in effect, and the Treasury Department proposed that the rules would be effective for brokers in 2025 for the 2026 tax-filing season. In the meantime, it is important for investors to accurately report and track their crypto activity.

Frequently asked questions