Crypto As An Investment: What You Need To Know

Cryptocurrency is a digital currency that can be used to buy goods and services or traded for profit. Bitcoin is the most widely used cryptocurrency. It is touted to lower transaction fees when compared to traditional online payment methods. Cryptocurrencies are traded between consenting parties with no broker and tracked on digital ledgers. They are powered by a technology known as blockchain, which maintains a tamper-resistant record of transactions and keeps track of who owns what. Cryptocurrency investing is fraught with risk and volatility, yet it has produced top returns for investors over time.

Crypto volatility and risk

Cryptocurrency is widely considered a risky and volatile investment. The price of crypto assets is often driven by media or social media hype and can rise and fall quickly and dramatically. This volatility is further accentuated by limited liquidity, which results in pronounced price changes during significant trading shifts.

Volatility

Volatility is a measure of how much the price of an asset has moved up or down over time. Generally, the more volatile an asset is, the riskier it is considered to be as an investment. Crypto is widely considered to be volatile, with the potential for significant upward and downward movements over shorter time periods.

Factors that can increase volatility include positive or negative news coverage, earnings reports, and unusually high or very low spikes in trading volume.

Risk

The risks associated with investing in cryptocurrency include:

• Liquidity risk: When trading on a crypto asset trading platform, there may not be enough crypto assets to cover your order. There are also no guarantees that demand for any given crypto asset will continue.
• Online risk: Crypto asset service providers and intermediaries may exist anywhere in the world, and it can be difficult or even impossible to identify or locate them and take action if you have a problem.
• Technical and cybersecurity risk: Technology and platforms used for crypto trading are susceptible to cybersecurity threats and hacking, putting your funds and crypto assets at risk.
• Theft or loss: A login ID and password are usually required to access a cryptocurrency exchange. If this is lost, hacked, or stolen, access could be denied or lost.
• Regulatory risk: Cryptocurrency issuance and trading are currently not extensively regulated, and additional oversight and regulation in the future are likely.
• Fraud and cybercrime: These are already issues in the world of crypto. Given the concerns above, cryptocurrencies could come under scrutiny from the Financial Crimes Enforcement Network (FinCEN) for non-compliance with the Bank Secrecy Act (BSA) and anti-money laundering requirements.

Strategies to Mitigate Risk

For crypto investors who are less risk-tolerant, there are strategies that can be used to limit the downside impact of volatility, such as dollar-cost averaging. There are also now cryptocurrencies specifically designed to have low volatility, called stablecoins.

Crypto's legal status

The legal status of cryptocurrencies varies from country to country. While some nations have explicitly allowed their use and trade, others have banned or restricted it.

Cryptocurrencies in the United States

Cryptocurrencies are not considered legal tender in the US. However, cryptocurrency exchanges are legal and fall under the regulatory scope of the Bank Secrecy Act (BSA). Cryptocurrency exchange service providers must register with the Financial Crimes Enforcement Network (FinCEN), which considers cryptocurrency tokens to be "other value that substitutes for currency". The Internal Revenue Service (IRS) does not consider cryptocurrency to be legal tender but defines it as "a digital representation of value that functions as a medium of exchange, a unit of account, and/or a store of value" and taxes it accordingly.

Cryptocurrencies in Canada

Cryptocurrencies are not legal tender in Canada but can be used to buy goods and services. Cryptocurrency exchanges are legal and must register with FinTRAC. Canada has been proactive in its treatment of cryptocurrencies, primarily regulating them under provincial securities laws.

Cryptocurrencies in Japan

Japan has the world's most progressive regulatory climate for cryptocurrencies. It recognises Bitcoin and other digital currencies as legal property under the Payment Services Act (PSA). Cryptocurrency exchange regulations in Japan are similarly progressive. Exchanges are legal but must register with the Financial Services Agency (FSA) and comply with strict AML/CFT and cybersecurity requirements.

Cryptocurrencies in the United Kingdom

The UK has no specific cryptocurrency laws, and cryptocurrencies are not considered legal tender. Cryptocurrency exchanges in the UK need to register with the Financial Conduct Authority (FCA) and comply with AML/CFT reporting obligations. Cryptocurrency gains or losses are subject to capital gains tax.

Cryptocurrencies in Switzerland

Switzerland has adopted a remarkably progressive stance towards cryptocurrency regulations. The Swiss Federal Tax Administration (SFTA) considers cryptocurrencies to be assets and subjects them to the Swiss wealth tax. Cryptocurrency exchanges must obtain a license from the Swiss Financial Market Supervisory Authority (FINMA) to operate.

Cryptocurrencies in the European Union

Cryptocurrencies are broadly considered legal across the European Union, but cryptocurrency exchange regulations vary by member state. Cryptocurrency taxation also varies, but many member states charge capital gains tax on cryptocurrency-derived profits. In 2020, the EU's Fifth Anti-Money Laundering Directive (5AMLD) brought cryptocurrency-fiat currency exchanges under EU anti-money laundering legislation.

Cryptocurrencies in China

China does not consider cryptocurrencies to be legal tender, and the country has a reputation for harsh cryptocurrency regulation. In 2021, it banned all domestic cryptocurrency mining and outlawed cryptocurrencies outright.

Cryptocurrencies in India

The status of cryptocurrencies in India remains unclear. While there is currently no legal framework for cryptocurrencies, the Supreme Court revoked the Reserve Bank of India's ban on cryptocurrency trade in 2020. The government is exploring the creation of a state-backed digital currency.

Crypto taxation

The taxation of cryptocurrencies varies across different countries. In the United States, the Internal Revenue Service (IRS) treats cryptocurrencies as property, not currency. This means that crypto transactions are considered taxable events, and capital gain and loss tax rules apply. Short-term capital gains (holding period of one year or less) are taxed at ordinary income tax rates, while long-term capital gains (holding period of more than one year) are taxed at lower rates. It's important to note that the IRS considers crypto digital assets and any transactions, including selling, exchanging, or gifting, need to be reported.

In India, cryptocurrencies are categorised as Virtual Digital Assets (VDAs) and are subject to a 30% tax on profits from trading, selling, or spending. Additionally, a 1% Tax Deducted at Source (TDS) is applied to crypto transactions exceeding a certain threshold.

Germany takes a different approach, treating cryptocurrencies as private assets rather than property. Short-term capital gains from crypto held for less than a year are taxed at regular income tax rates of up to 45%, plus a 5.5% Solidarity Tax. However, if the profits are below a certain threshold (e.g. €600), they are tax-free. Long-term holdings (over a year) are considered tax-free.

Each country has its own specific rules and regulations regarding the taxation of cryptocurrencies, and it's important for investors to understand the tax implications in their respective jurisdictions.

Crypto's future as a global currency

The future of cryptocurrency is uncertain. While some analysts predict that the global cryptocurrency market will more than triple by 2030, reaching a valuation of nearly $5 billion, others argue that it is a passing fad that will flame out before long.

One of the main challenges facing cryptocurrency is regulation. Crypto investors believe in regulation, but are concerned about its impacts. They want crypto to be legitimized, enabling more businesses to accept it, increasing its value, security, and stability. However, they also worry that regulation could limit its peer-to-peer nature and anonymous transactions, which are some of crypto's biggest advantages.

Another issue is the environmental impact of crypto. Crypto investors are increasingly eco-conscious, but cryptocurrency has a huge carbon footprint due to the significant amount of energy required for mining.

Additionally, there are concerns about the volatility and security of cryptocurrencies. The value of cryptocurrencies can fluctuate wildly, making them risky investments. Moreover, crypto exchanges and wallets have been hacked, resulting in millions of dollars in losses.

Despite these challenges, there is growing interest in cryptocurrency from both individual and institutional investors. Traditional finance companies are also starting to cater to the increased demand for crypto.

It remains to be seen whether cryptocurrency will become a global currency. While some countries, like El Salvador and the Central African Republic, have adopted Bitcoin as legal tender, others, like China, have banned it. The future of cryptocurrency will depend on how well it navigates the challenges of regulation, environmental impact, volatility, and security.

Crypto's viability as a hedge against inflation

Cryptocurrencies like Bitcoin have become increasingly popular as a refuge against inflation. However, their effectiveness as a hedge is debated due to the volatility and unpredictability of the crypto market.

Bitcoin, for instance, has been touted as a hedge against inflation due to its finite supply of 21 million coins, which stands in contrast to fiat currencies like the US dollar, which can be printed in unlimited quantities by central banks and are subject to inflation targets. This built-in scarcity in Bitcoin is intended to prevent the devaluation that can occur with fiat currencies when more of the currency enters circulation.

Additionally, Bitcoin's decentralized nature means it operates outside the direct control of central banks and government monetary policies, providing independence from centralized economic decisions that can lead to inflation.

However, the very nature of cryptocurrencies, with their lack of central governance, also presents challenges. The crypto market is highly volatile, and the value of Bitcoin has experienced sharp rallies and declines, even as inflation data consistently ticked higher. The lack of a central authority also means that consumer protections are minimal or non-existent, and transactions are irreversible, increasing the risks for investors.

Furthermore, the regulatory landscape for cryptocurrencies is complex and ever-changing, with global regulatory actions significantly influencing the market. The entry of renowned investors and financial institutions into the Bitcoin arena demonstrates growing confidence, but the future of Bitcoin as a hedge against inflation is still uncertain.

While cryptocurrencies offer a unique solution as a hedge against inflation due to their finite supply and decentralized nature, they also come with inconveniences and risks. For cryptocurrencies to become a reliable hedge, they need to establish their fundamentals and achieve mass adoption. The crypto community needs to address issues like high energy consumption, security concerns, and the inefficiencies of decentralized exchanges.

In conclusion, cryptocurrencies have the potential to act as a hedge against inflation, particularly in steady growth environments. However, their effectiveness is currently limited by market volatility, regulatory uncertainties, and the need for broader adoption. As the crypto space continues to evolve and mature, the viability of cryptocurrencies as a hedge against inflation may improve over time.

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