The Future Of Cryptocurrency: Easy Investment Or Complex Challenge?

Investing in cryptocurrency is not without its risks. Cryptocurrency is a digital currency that can be used to buy goods and services or traded for profit. It is secured by blockchain technology and has no central authority to verify transactions or create new units. While it has moved into the mainstream as an investment asset class, it is currently unregulated, and investing in it can be a gamble.

There are thousands of cryptocurrencies to choose from, and the market is extremely volatile. The prices of cryptocurrencies, even the most established ones, fluctuate wildly and are much more unpredictable than the prices of other assets like stocks.

The process of investing in cryptocurrency is relatively straightforward. You can use a cryptocurrency exchange to buy, sell, and hold cryptocurrency, and you will need a digital wallet to store your purchases safely. However, it is important to do your research before investing, as the crypto market is complex and prone to scams and theft.

In summary, while investing in cryptocurrency is relatively easy, it is a risky venture that may not be suitable for everyone.

How to buy cryptocurrency

Investing in cryptocurrency is risky and volatile, but it has produced top returns for investors over time. Here is a step-by-step guide on how to buy cryptocurrency:

Choose a Broker or Crypto Exchange

You can buy cryptocurrency through a crypto exchange or a broker. Exchanges tend to have lower fees but more complex interfaces, while brokers take the complexity out of purchasing crypto but often charge higher fees. Some well-known exchanges include Coinbase, Gemini, and Binance.US, and some well-known brokers include Robinhood and SoFi.

Create and Verify Your Account

After deciding on a platform, you will need to create an account and verify your identity to prevent fraud and meet regulatory requirements. This may involve submitting a copy of your driver's license or passport, and sometimes a selfie.

Deposit Cash to Invest

To buy crypto, you will need to deposit money into your account. You can do this by linking your bank account, authorizing a wire transfer, or using a debit or credit card. Be aware that credit card companies process cryptocurrency purchases as cash advances, which are subject to higher interest rates and additional fees.

Place Your Cryptocurrency Order

Once your account is funded, you can place your first cryptocurrency order. There are hundreds of cryptocurrencies to choose from, ranging from well-known names like Bitcoin and Ethereum to more obscure options. With most platforms, you can purchase fractional shares of cryptocurrency.

Select a Storage Method

Cryptocurrency exchanges are not backed by protections like the Federal Deposit Insurance Corporation (FDIC), so it's important to choose a secure storage method. You can leave your crypto on the exchange or transfer it to a separate hot or cold wallet. Hot wallets are stored online and are more convenient but carry a higher risk of theft. Cold wallets, on the other hand, are not connected to the internet and are considered the most secure option.

The risks of investing in cryptocurrency

Cryptocurrency is a highly speculative and risky investment option. Here are some of the key risks associated with investing in cryptocurrency:

High Volatility and Price Risk

Cryptocurrency prices are extremely volatile and subject to rapid and significant price swings. The values of cryptocurrencies can fluctuate dramatically, resembling roller-coaster rides. The high volatility is driven by various factors, including a vibrant global crypto community that operates 24/7, high degrees of automation, and the impact of news and social media hype. These factors contribute to dynamic price movements and massive hypes that can end as quickly as they start.

Regulatory and Tax Risks

The cryptocurrency market is currently unregulated or lightly regulated in many jurisdictions. Government bodies worldwide are still figuring out how to manage and regulate cryptocurrencies. The lack of clear regulatory frameworks creates uncertainty for investors, and the legal landscape can change quickly. It is the individual's responsibility to ensure they comply with tax obligations, which can be complex and vary across jurisdictions.

Cybersecurity and Scams

Cryptocurrency exchanges and investors are frequent targets of cybersecurity threats, scams, and hacking attempts. The decentralized nature of blockchain technology makes it susceptible to malicious attacks and infiltration by groups with malicious intent. It is crucial for investors to practice good digital hygiene, enable strong security measures, and choose secure wallet and exchange platforms to protect their investments.

Technical Complexity and User Errors

The technical complexity of the cryptocurrency space can lead to user errors, such as sending funds to the wrong address or falling victim to phishing attacks. Transactions on the blockchain are often irreversible, making it difficult or impossible to recover lost funds due to user mistakes.

Limited Intrinsic Value and Valuation Challenges

Cryptocurrencies, unlike stocks, lack concrete financial metrics, making their valuation ambiguous and challenging. They have zero intrinsic value and are not backed by any physical asset or government. The long-term prospects of cryptocurrencies can be hazy, making it difficult to predict their future performance and conduct proper market-value analyses.

Centralization and Governance Risks

While cryptocurrencies themselves are decentralized, the business entities issuing them may not be. Some cryptocurrency projects rely on a trusted entity to act in the best interests of the project. This centralization introduces risks related to mismanagement, divergence of interests, and potential inside attacks by malicious team members.

Environmental Impact

The energy-intensive nature of cryptocurrency mining, particularly for coins like Bitcoin, has raised concerns about the environmental impact of the industry. The significant power consumption required for mining activities has led to criticism and potential regulatory scrutiny.

The legal status of cryptocurrency

In the UK, cryptocurrencies are not considered legal tender, and exchanges have registration requirements with the Financial Conduct Authority (FCA). Cryptocurrency gains or losses are subject to capital gains tax.

In the EU, cryptocurrencies are broadly considered legal, but exchange regulations vary by member state. Cryptocurrency taxation also varies, but many member states charge capital gains tax on cryptocurrency-derived profits.

In Canada, cryptocurrencies are not legal tender but can be used to buy goods and services. Cryptocurrency exchanges are legal and must register with the Financial Transactions and Reports Analysis Centre of Canada (FinTRAC).

In Japan, cryptocurrencies are legal and recognised as property under the Payment Services Act (PSA). Cryptocurrency exchanges are legal but must register with the country's Financial Services Agency (FSA).

In Australia, cryptocurrencies and exchanges are legal. Cryptocurrencies are treated as property and are subject to Capital Gains Tax (CGT). Cryptocurrency exchanges must register with the Australian Transaction Reports and Analysis Centre (AUSTRAC).

In China, cryptocurrencies are not legal tender, and domestic cryptocurrency exchanges are banned.

Other countries with varying approaches to the legal status of cryptocurrency include India, South Korea, Singapore, Switzerland, Estonia, Gibraltar, Luxembourg, Malta, and Latin American countries such as Mexico, Argentina, Brazil, and Chile.

How to store cryptocurrency

When you own cryptocurrency, storing it is your responsibility. If you lose access to your crypto, it is probably gone forever. There are several options for storing your cryptocurrency, each with its own pros and cons. These include hardware devices, applications, and even a simple piece of paper.

Hardware Wallets

Hardware wallets are small physical devices that connect to your computer and store cryptocurrency offline. They connect to the internet when sending and receiving cryptocurrency. Examples include Ledger, Trezor, and SafePal. While hardware wallets are considered the safest option, they are less convenient than other methods.

Software Wallets

Software wallets are applications that can be downloaded to your desktop or mobile device, or used as a browser extension. They are almost always free and easy to use, but they are vulnerable to hacking.

Custodial Wallets

Custodial wallets are controlled by a third party, such as a crypto exchange, that stores your cryptocurrency for you. They are convenient and easy to use, but they are less secure than hardware wallets. Examples include Coinbase, Gemini, Robinhood, and PayPal.

Paper Wallets

Paper wallets are the simplest and cheapest option for storing cryptocurrency. They involve printing out your public and private keys, usually as a string of characters and scannable QR codes. Paper wallets are secure because they are offline, but they are inconvenient and less user-friendly than other methods.

Best Practices for Storing Cryptocurrency

• Store the majority of your crypto in a cold wallet (offline) because it is the most secure option.
• Use a hot wallet (online) for smaller amounts of crypto that you want to have readily available for trading.
• Physically record the recovery phrases for your crypto wallets and keep them in a secure location.
• Never share your recovery phrase or private keys with anyone, and don't save them to your computer.

The tax implications of investing in cryptocurrency

Investing in cryptocurrency is risky, and it is important to understand the tax implications of using crypto, especially if you purchase or sell your crypto investments.

The Internal Revenue Service (IRS) treats cryptocurrencies as property for tax purposes. This means that any profits or income from your cryptocurrency is taxable. If you hold a cryptocurrency, sell it, and profit, you owe capital gains tax on that profit, just as you would on a share of stock. If you use crypto to buy goods or services, you owe taxes on the increased value between the price you paid and its value at the time of the transaction, plus any other taxes triggered. If you accept crypto as payment for goods or services, you must report it as business income. If you are a crypto miner, the value of your crypto at the time it was mined counts as income.

Cryptocurrency taxes are complicated because they involve both income and capital gains taxes. In most cases, you are taxed multiple times for using cryptocurrency. It is best to consult an accountant familiar with cryptocurrency and current practices to ensure you are reporting taxes correctly.

There are several types of cryptocurrency tax events, including:

• Sale of a digital asset for fiat currency
• Exchange of a digital asset for property, goods, or services
• Exchange or trade of one digital asset for another
• Receipt of a digital asset as payment for goods or services
• Receipt of a new digital asset as a result of a hard fork
• Receipt of a new digital asset as a result of mining or staking activities
• Receipt of a digital asset as a result of an airdrop
• Any other disposition of a financial interest in a digital asset

However, there are also some situations that are not taxable events, such as buying cryptocurrency with fiat money, donating crypto to a tax-exempt non-profit or charity, or making a gift of cryptocurrency to a third party (subject to gifting exclusions).

When it comes to calculating your crypto taxes, you need to consider your income, gains, and losses. Your crypto income includes any crypto you receive as income, such as from mining, staking, or rewards. Your gains or losses are the difference between the price you paid for the crypto and its value when you sold or used it in a transaction. Short-term capital gains or losses apply if you held the crypto for one year or less, while long-term capital gains or losses apply if you held it for more than a year.

Frequently asked questions