Investing 401(K) In Bitcoin: Wise Or Risky Move?

Bitcoin and other cryptocurrencies are available to 401(k)s, IRAs, and other retirement plans, although usually indirectly. However, many retirement plan managers maintain a distance from cryptocurrency because of skepticism about its value and wariness of its volatility.

If you're thinking about investing in Bitcoin with your 401(k), there are a few things you should know. Firstly, you'll need to establish or possess a 401(k) funded with traditional forms of money, such as cash, checks, or money orders, as contributions of property, including cryptocurrencies, are not permitted. Secondly, investing in cryptocurrency carries significant risks due to its volatile nature.

Before deciding whether to invest in Bitcoin with your 401(k), it's essential to carefully consider the potential benefits and drawbacks and consult with a financial advisor to ensure it aligns with your financial goals.

Bitcoin's value as a non-correlated asset

Bitcoin is a decentralised digital currency, also known as a cryptocurrency, that was created in 2009 by an unknown person or group of people using the pseudonym Satoshi Nakamoto. It operates on blockchain technology, a public ledger that verifies transactions through cryptography and records them in a publicly accessible format.

Bitcoin is not correlated with traditional markets. Fidelity Digital Assets, an investment firm, found that Bitcoin's correlation to other assets from January 2015 to September 2020 was an average of 0.11, indicating almost no relationship between the returns of Bitcoin and other assets. This is supported by various high-profile investors, including Anthony Pompliano, co-founder of Morgan Creek Digital Assets, who states that Bitcoin has a "low to no correlation over any material amount of time".

Bitcoin's lack of correlation with traditional markets makes it a valuable hedge asset. Many people view Bitcoin as an insurance-like instrument that will protect their wealth in the event of a systemic failure. This is especially true in cases of hyperinflation, where Bitcoin can serve as a hedge against government currency failure. For example, during Venezuela's hyperinflation, only a handful of assets maintained any value; gold and cryptocurrency.

Bitcoin's status as a non-correlated asset also makes it a good store of value. With a fixed total supply of 21 million BTC, it has the potential to act as a functional currency in the future. While it may take some time for Bitcoin to become widely accepted as a currency, it is already solidifying itself as a viable hedge asset.

In summary, Bitcoin's value as a non-correlated asset lies in its potential to serve as a hedge against systemic failures and government currency failures, as well as its potential to act as a functional currency and store of value in the future.

The risks of investing in Bitcoin

Investing in Bitcoin and other cryptocurrencies is risky and highly volatile. Here are some of the key risks to be aware of:

Volatility and Fluctuations

The cryptocurrency market is unpredictable and subject to rapid changes. The price of Bitcoin can fluctuate significantly in a short period, making it challenging to determine if you will get a return on your investment. Small investments are generally recommended to minimise the risk of significant losses.

Cyberattacks and Fraud

The reliance on technology and digital storage methods makes Bitcoin investors vulnerable to cyberattacks, online fraud, and system failures. Hacking is a serious risk, as there may be no way to retrieve lost or stolen Bitcoins. Additionally, fraud is prevalent in the Bitcoin market, with fake exchanges and other scams duping unsuspecting investors out of their investments.

Lack of Regulation

Currently, the Bitcoin market operates with little to no major regulations, as governments and regulatory bodies are still figuring out their stances on cryptocurrencies. The lack of taxation and clear government policies could lead to future problems, especially if Bitcoin poses competition to government-issued currencies.

Technology Reliance and System Shutdowns

As a digital currency, Bitcoin is entirely reliant on technology. Without the underlying technology, Bitcoin and other cryptocurrencies become worthless. Investors are more vulnerable to cyber threats, and a system shutdown could result in significant losses.

Block Withholding and Centralised Control

The process of creating new Bitcoins through "blocks" can be manipulated by mining pools, who can use their computational power to hide blocks from honest miners. This centralisation of control allows a few select individuals to benefit at the expense of others, undermining the decentralised nature of Bitcoin.

Ponzi Scheme and Bubble Economy 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 forms, and when it bursts, Bitcoin may become useless, leaving many investors with significant financial losses.

In conclusion, while Bitcoin may offer potential opportunities, it is a highly speculative and volatile investment. Investors must exercise caution and conduct thorough research before allocating any funds to Bitcoin or other cryptocurrencies.

How to invest in Bitcoin with a 401k

Investing in Bitcoin with a 401(k) is possible, but it depends on your situation. Here is a step-by-step guide on how to invest in Bitcoin with a 401(k):

Step 1: Understand the Risks and Benefits

Before investing in Bitcoin with your 401(k), it is important to understand the risks and benefits involved. Bitcoin is a highly volatile and speculative asset, and its value is largely based on speculation. While it has the potential for high returns, there is also a significant risk of loss. Therefore, it is generally recommended that Bitcoin should only make up a small percentage of your retirement portfolio.

Additionally, it is important to note that Bitcoin is not a stock and does not pay dividends or distribute capital gains. As such, allocating funds to Bitcoin in a retirement account designed for income requires careful consideration.

Step 2: Check with Your Employer

The availability of Bitcoin as an investment option within your 401(k) depends on your employer. Typically, employers offer a limited menu of investment choices, such as mutual funds and ETFs. However, some employers may offer a self-directed 401(k) option, which allows you to invest in a broader range of assets, including cryptocurrencies. Contact your HR department to find out if this is available at your company.

Step 3: Consider a Self-Directed IRA

If your employer does not offer a self-directed 401(k) or if you are self-employed, you can explore opening a self-directed Individual Retirement Account (IRA). A self-directed IRA allows you to invest in alternative assets that are not typically available in traditional IRAs, such as cryptocurrencies. This option gives you more control over your investment choices.

Step 4: Find a Crypto IRA Company

If you decide to open a self-directed IRA, you will need to find a company that allows you to include crypto in the account. Examples of crypto IRA companies include BitIRA, Equity Trust Company (ETC), and iTrustCapital. Ensure that the company is legitimate, regulated, and compliant with IRS guidelines.

Step 5: Fund Your Crypto-Compatible Retirement Account

Once you have chosen a crypto IRA company, you will need to fund your crypto-compatible retirement account. You can do this by sending contributions to the account, transferring funds from your existing account, or rolling over your employer-sponsored plan into a Rollover IRA that allows cryptocurrency. Make sure to stay within the maximum contribution limits, which are $7,000 for individuals under 50 and $8,000 for individuals 50 and older in 2024.

Step 6: Purchase Cryptocurrency

After your account is funded, you can start purchasing cryptocurrency, such as Bitcoin, from the account. Remember to consider any fees involved, including blockchain and exchange transaction fees, as well as any annual or trading fees charged by the IRA company.

Step 7: Store Your Cryptocurrency Securely

Finally, it is important to ensure the secure storage of your cryptocurrency. You can use a digital or Bitcoin wallet to store your crypto assets, such as BitIRA's fully-insured cold storage wallet solution.

In summary, investing in Bitcoin with a 401(k) can be done through a self-directed 401(k) or a self-directed IRA. However, it is important to carefully consider the risks and regulations involved and consult with a financial advisor before making any investment decisions.

The tax benefits of investing in Bitcoin with a 401k

Investing in Bitcoin with a 401(k) can offer certain tax benefits. The IRS categorises Bitcoin as "property" for Federal Tax purposes. This means that any gains accrued from investing in Bitcoin with a 401(k) can be retained tax-free until you take a distribution. Additionally, if you buy Bitcoin for your IRA and sell it later, you can reinvest your capital into any IRA-eligible asset and still get tax-deferred benefits. These assets can include stocks, bonds, mutual funds, ETFs (exchange-traded funds), precious metals, private equity, certain types of real estate, and more.

However, it is important to note that the IRS guidelines state that contributions to retirement accounts must be in the form of money (cash, checks, or money orders) and not property, including cryptocurrencies. Therefore, to invest in Bitcoin with a 401(k), you need to establish or possess a 401(k) funded with traditional forms of money.

It is also worth mentioning that investing in Bitcoin through a self-directed IRA (SDIRA) can provide similar tax benefits. With a SDIRA, you can invest in a range of alternative assets, including Bitcoin, and still enjoy tax advantages.

The future of Bitcoin as a hedge asset

Bitcoin is seen by many as a hedge asset. Many bitcoin holders believe that it is wise to allocate a certain percentage of their net worth into an asset that is not controlled by a central entity. Bitcoin is an open-source, decentralised network, and many believe it is an emerging store of value.

Bitcoin is often compared to precious metals, like gold, and viewed as an insurance-like instrument that will protect wealth in the event of a systemic failure. An allocation to an asset seen as a store of value and a hedge against governmental or central bank errors represents a responsible and reasonable approach.

Bitcoin's volatility has steadily declined since its launch, and it can act as a countercyclical asset. However, it is still relatively more volatile than traditional equities. Bitcoin's correlation with stocks is likely to tighten as it becomes more mainstream and accessible to a wider range of investors.

Some conventional assets, such as the Dow Jones, S&P 500, and certain commodities, can hedge wild swings in Bitcoin prices. These assets can be used to reduce the overall volatility of a portfolio that includes Bitcoin.

While Bitcoin has the potential to be a hedge asset, it is important to note that it is still a risky and highly volatile investment. The recent collapse of the FTX cryptocurrency exchange is a reminder of the risks associated with cryptocurrencies.

Frequently asked questions