Smart Strategies For Bitcoin Investment: How Much To Invest?

Bitcoin is a decentralised digital currency that operates without the oversight of banks and governments. It is the first and largest cryptocurrency by market cap and has been making headlines for its eye-popping returns. But how much should you invest in Bitcoin?

Most financial experts recommend limiting crypto exposure to less than 5% of your total portfolio. Crypto is considered a high-risk, volatile asset class, and limiting allocation helps manage overall volatility and risk. If you are new to crypto investing, you may want to start with 1% to 2% of your portfolio.

It's important to remember that cryptocurrencies are still relatively new and extremely volatile assets. The most important rule of investing in crypto is never to invest more than you can afford to lose.

There are several ways to buy Bitcoin, including cryptocurrency exchanges, traditional stockbrokers, money transfer apps, Bitcoin ATMs, and Bitcoin exchange-traded funds (ETFs). When deciding how much to invest, consider your risk tolerance, financial position, and whether you can afford to lose some or all of your investment.

Risks and volatility

Bitcoin is a relatively new and highly volatile asset. Its price is constantly changing, making it difficult to predict whether you will get a return on your investment. For example, on November 6, 2018, one bitcoin was worth $6,461.01. Just over a week later, on November 14, 2018, buyers could not sell their investment for more than $5,619.88.

As a new and volatile asset, investing in Bitcoin carries significant risk. Here are some of the key risks to consider:

Volatile and Fluctuating Market

The unpredictable nature of the Bitcoin market means there is no guarantee of a return on investment. To avoid massive losses, it is important to closely monitor the market and make small investments over time. This will help to reduce the impact of volatility and provide more beneficial long-term results.

Cyber Attacks and Fraud

Bitcoin is vulnerable to cyber attacks and fraud due to its technology-dependent nature. Hacking is a serious risk, as there is currently no way to retrieve lost or stolen bitcoins. Additionally, the lack of security in the Bitcoin market creates a significant risk for investors, with many buyers losing their investments through fraudulent exchanges.

Little or No Regulation

The Bitcoin market currently operates with little to no major regulations. Governments and financial authorities are still trying to understand and define the legal implications of cryptocurrencies. This lack of regulation can create legal and financial risks for investors, particularly regarding taxation and reporting requirements.

Technology Reliance

As a digital currency, Bitcoin is entirely reliant on technology. Without the underlying technology, Bitcoin has no value. This reliance on technology also exposes Bitcoin owners to cyber threats, online fraud, and the risk of system failures or shutdowns.

Block Withholding

The process of creating new bitcoins through "block" mining can be manipulated by a select few, who use computational power to hide new blocks from honest miners. This practice allows a small group to benefit at the expense of others, undermining the decentralised nature of Bitcoin.

Ponzi Scheme Concerns

Some critics argue that Bitcoin operates as a Ponzi scheme, where people at the top benefit from the ignorance of others. As more people invest, a bubble economy is created. When this bubble bursts, Bitcoin may become useless, leaving many people unable to sell and facing significant financial losses.

Lack of Wide Acceptance

Despite its popularity, Bitcoin is not widely accepted as a legitimate form of currency. Only a small number of companies, such as Overstock, Newegg, and Monoprix, allow cryptocurrency exchanges. This limited acceptance adds to the risk of investing in Bitcoin, as it may impact the ability to use or liquidate holdings in the future.

Tax Implications

Investing in Bitcoin can create complex tax obligations, as cryptocurrencies are typically treated as property rather than currencies for tax purposes. Capital gains and losses must be reported whenever Bitcoin or other cryptocurrencies are sold or traded. It is important to consult with a tax professional familiar with cryptocurrency to ensure compliance with applicable tax laws.

Security Risks

The lack of central authority backing Bitcoin means that investors may face legal complications in the event of transactions or ownership disputes. Additionally, the decentralised nature of Bitcoin means that there is often no standard practice for recovering missing funds in the event of a cryptocurrency exchange hack.

Fraud and Money Laundering

There are concerns that the decentralised nature of cryptocurrencies provides criminal organisations with new opportunities for fraud, money laundering, and other financial crimes. While this may not directly impact most investors, it highlights the potential legal and financial risks associated with the lack of central authority in the Bitcoin market.

How much to allocate

How much you should allocate to Bitcoin depends on your financial situation, risk tolerance, and investment goals. Here are some guidelines and considerations to help you determine how much to invest in Bitcoin:

Start Small and Gradually Increase

When investing in Bitcoin, it's generally recommended to start small, especially if you are new to the market. You can begin with a minimal amount, such as less than $10, to get a grasp of how the process works. This allows you to familiarise yourself with the market dynamics and reduce the potential impact of losses. As you gain more knowledge and confidence, you can gradually increase the amount you invest over time.

Percentage of Your Portfolio

A common rule of thumb is to allocate no more than 10% of your investment portfolio to individual stocks or risky assets like Bitcoin. This helps to diversify your investments and manage risk. For those new to crypto investing, starting with as little as 1% to 2% of your portfolio can be a conservative introduction. It's important to remember that Bitcoin is a highly volatile asset, and you should only invest an amount you are comfortable with losing.

Dollar-Cost Averaging

Consider using a dollar-cost averaging strategy, which involves making small, recurring purchases of Bitcoin on a set schedule, such as weekly or monthly. This approach helps to reduce the impact of market volatility by buying more when prices are low and less when prices are high. Automating these purchases through an exchange can be beneficial and save you from trying to time the market.

Assess Your Financial Situation

Before allocating funds to Bitcoin, ensure that you have sufficient emergency savings and that your basic financial needs are met. It's crucial to invest only what you can afford to lose, as the cryptocurrency market is highly volatile. Avoid taking on debt, especially high-interest credit card debt, to invest in Bitcoin, as this can lead to significant losses if the market turns downward.

Diversification

Diversification is an important aspect of investing. While Bitcoin has the potential to offer high returns, it's essential to diversify your investments across various asset classes to reduce risk. Consider allocating a portion of your portfolio to more traditional investments, such as stocks, bonds, or real estate, in addition to cryptocurrencies. This helps to balance your overall risk exposure.

Long-Term Investment Horizon

Bitcoin is a long-term investment, and its value can fluctuate significantly over time. It's important to have a long-term investment horizon when allocating funds to Bitcoin. Be prepared for potential downturns and market volatility, and avoid making investment decisions based on short-term price movements.

Research and Education

Before allocating a significant portion of your portfolio to Bitcoin, ensure you thoroughly understand the technology, the market, and the risks involved. Conduct thorough research, follow market trends, and stay informed about regulatory developments. Remember that investing in Bitcoin should be based on your own financial situation, risk tolerance, and investment goals.

Where to buy

There are several options for buying Bitcoin. Here are some of the most popular platforms:

Coinbase

Coinbase is a popular and trusted cryptocurrency exchange that allows users to buy, sell, trade, store, and stake various cryptocurrencies, including Bitcoin. It offers advanced trading tools, real-time order books, and charting capabilities. Coinbase also provides a secure crypto wallet, a user-friendly interface, and educational resources for beginners. It is the only publicly traded crypto exchange in the US, and its financials are audited by a Big 4 accounting firm.

Binance

Binance is the world's leading cryptocurrency exchange, with over 169 million registered users in more than 180 countries. It offers low fees, a wide range of cryptocurrencies to trade (including Bitcoin), and various tools for buying and selling. Binance supports multiple payment methods, including credit/debit cards, cash balance, and Apple Pay/Google Pay. Before using Binance, users need to complete identity verification and register an account.

BitPay

BitPay is a licensed platform that enables users to buy and sell Bitcoin and engage in Virtual Currency Business Activity. It offers an app for self-custody and a help library for user support.

Other Options

Other platforms that allow users to buy and sell Bitcoin include Crypto.com, MoonPay, Kraken, Robinhood, Uphold, and Webull. Each platform may offer different features, payment options, and security measures, so it is essential to research and choose the one that best suits your needs.

How to store

When it comes to storing Bitcoin, there are two main types of wallets: hot wallets and cold wallets. Hot wallets are connected to the internet, while cold wallets are offline and thus less susceptible to hacking.

Hot Wallets

Hot wallets are a convenient way to store Bitcoin, as they are typically free and easy to use. They are usually provided by the exchange where you buy your Bitcoin, but you can also download a third-party hot wallet app. However, because they are connected to the internet, hot wallets are vulnerable to hacking. It is recommended that you only keep small amounts of Bitcoin in a hot wallet for everyday transactions and store the majority of your Bitcoin in a more secure cold wallet.

Cold Wallets

Cold wallets are considered the safest way to store Bitcoin because they are not connected to the internet and are therefore inaccessible to hackers. There are several types of cold wallets:

• Hardware wallets are small, encrypted portable devices, similar to USB drives, that allow you to download and carry your Bitcoin. They typically cost around $100.
• Paper wallets involve printing out your public and private keys, usually as QR codes, and storing them in a safe place. This method is affordable and secure but has a high risk of user error or wallet damage.
• Desktop wallets are programs that reside on your computer. They are not considered a safe storage method because they are susceptible to hacking.
• Mobile wallets are programs hosted on your mobile device. These are not very secure because your device can be hacked.
• Web-based wallets are hosted by a web service and are not secure because you are allowing a third party to store your keys.

When choosing a cold wallet, it is important to back it up regularly and use a strong password and two-factor authentication. You should also be aware of the risk of losing your cold wallet, as they are small and easily misplaced.

Taxes and regulations

Bitcoin is a decentralised digital currency, meaning there is no central authority, government, or bank in charge of it. However, despite its decentralised nature, Bitcoin is still subject to taxation laws and regulations.

Taxation

Bitcoin is taxed, but how it is taxed depends on how and when you acquired it. If you sell Bitcoin for a profit, you are taxed on the difference between your purchase price and the proceeds of the sale. This includes exchanging Bitcoin for another cryptocurrency, or using Bitcoin to pay for goods and services.

If you acquired Bitcoin through mining, or as payment for goods or services, that value is taxable immediately as earned income. If you dispose of or use Bitcoin by cashing it in on an exchange, buying goods and services, or trading it for another cryptocurrency, you will owe taxes if the realised value is greater than the price at which you acquired the crypto.

The tax rate depends on two factors: how long you owned the Bitcoin before selling, and your total income for the year. If you owned Bitcoin for one year or less before selling, you will be taxed at a higher rate (between 10% and 37%). If you owned Bitcoin for more than a year, your tax rate will be between 0% and 20%. The highest tax rates apply to those with the largest incomes.

It is important to keep careful records of your transactions, as the onus is on individuals to keep track of their gains and losses. You will need records of the fair market value of your Bitcoin when you mined or bought it, as well as when you used or sold it.

While trading one crypto for another triggers a taxable event, you can write off Bitcoin losses. If you sell Bitcoin for less than you bought it for, the amount of the loss can offset the profit from other sales. The maximum amount you can write off in one year is $3,000.

Regulations

Although Bitcoin is decentralised and semi-anonymous, authorities have been catching up with tracking and tracing Bitcoin as part of criminal investigations. The Internal Revenue Service (IRS) in the US, for example, has been stepping up enforcement efforts and generating publicity in going after people who hold, trade, or use cryptocurrency. This makes it all the more important for those who transact in Bitcoin to know the law and any potential tax liabilities.

The good news is that the IRS generally treats cryptocurrencies similarly to how it treats other capital assets such as stocks and bonds. The bad news is that this treatment makes it difficult to use cryptocurrency to buy goods and services. Every time you exchange virtual currency for real currency, goods, or services, you may create a tax liability if the price you realise is greater than your cost basis in the cryptocurrency.

In terms of gifting or inheriting Bitcoin, the cost basis remains the same as the giver's or deceased's cost basis. Gifting Bitcoin is subject to the gift tax if it is over a certain amount ($17,000 in 2023 or $18,000 in 2024 in the US). Inherited Bitcoin may be subject to estate taxes if the estate exceeds certain thresholds.

It is worth noting that the wash-sale rule, which applies to other capital assets, does not apply to cryptocurrency. This means that traders can sell their position, book a loss, and then immediately buy back the asset, still being able to claim the loss. However, this loophole may potentially close in the near future as legislators have been discussing its removal.

Frequently asked questions