The field of cryptocurrency is forever expanding with over 4,000 cryptocurrencies[i] in existence as of January 2021. But what in the world is cryptocurrency? How does it differ from real money? And should I be adding this to my portfolio?
These are all questions our clients have been asking as we’ve seen this year’s Bitcoin frenzy unfold, especially after its sudden surge to over $50,000 per coin—representing a 150%[ii] gain in value over the course of a few short months. Some other cryptocurrencies have had even bigger gains in a similar period. So is this an investment worth looking into?
What is Cryptocurrency?
Cryptocurrency is simply a digital asset or medium of exchange. In layman’s terms, it is a virtual currency. However, unlike with traditional money, there are no tangible coins or bills that are exchanged. Each “coin” is owned and recorded digitally using code in an existing ledger. These ledgers use strong cryptography or encryption algorithms to (a) secure transaction records, (b) control the creation of additional coins, and (c) verify the transfer of coin ownership. For Bitcoin, these ledgers are referred to as blockchain.
Blockchain is a specific type of database that stores linked information together using a set of chronologically created records. These records are created using cryptography and work in such a way that no single group or user has control over the currency. Rather, all users collectively maintain control. As new data is entered into a fresh block, it begins filling the block. Once the block is filled with data, it is then chained onto the previous block, which keeps the chained data in chronological order.[iii]
In essence, blockchains create a strong, yet globally decentralized check-and-balance system. The competition among thousands of blockchain miners keeps everyone relatively honest, as any attempted “cheating” by cryptocurrency holders or miners should, in theory, be promptly detected.[iv]
But, because of this decentralized system, there is no single regulatory agency. Bitcoin “miners” compete against one another for the role. Each block is secured with a complex mathematical equation, and the miner that solves that equation first gets to add the new block to a blockchain. The reward? As much as tens of thousands of dollars for setting a single block.[v]
However, there is a limited number of bitcoin that can be mined—21 million to be exact. As of January 30, 2021, there is approximately 18,614,806 bitcoin in existence and 2,385,193 bitcoin left to be mined. When you purchase Bitcoin, you are given a private encryption key that gives you access to the coin. Without this key, you cannot access or exchange your Bitcoin.[vi]
Investing in Cryptocurrency
Even though it is not considered legal tender everywhere yet, bitcoin can be exchanged for traditional currency. For investors interested in these types of currency exchanges, Bitcoin can be very attractive. They can even act as an alternative to national fiat money and commodities like gold.
Currently, the Bitcoin and cryptocurrency market is riding high. While you probably won’t be able to buy a whole Bitcoin, you can buy fractions of one for as little as $50. To do so, you would purchase Bitcoin on an exchange like Coinbase or invest through capital markets and index funds.
The Risks
Investing in Bitcoin might sound like a great investment strategy if you are interested in technology and digital products, but keep in mind that just like any new investments, there are a number of significant risks to consider. When it comes to Bitcoin, the risks may be even higher due to its novelty and extremely volatile nature.
· Regulatory Risks
Governments around the world are just now starting to try and regulate Bitcoin and other cryptocurrencies. Because they are not government currency, they can be used for many illicit activities such as money laundering, illegal activities, or even tax evasion. As governments begin to further restrict Bitcoin, questions arise about its liquidity and longevity.
· Security Risks
If you’ve purchased your currency on a Bitcoin Exchange, you may be exposed to risk of loss by hackers, malware, or other security breaches as your private encryption key can be stolen just like a credit card number or bank password. And you can lose your key in just the same way you can lose your credit card; however, there isn’t any bank you can call up to cancel your encryption key and request a new one. Losing the key could mean forfeiting your entire Bitcoin wallet, and all the value associated with it (that cannot be recovered).
· Insurance Risks
In most cases, Bitcoin is not insured by any type of government program like other investments. That said, as of 2019, SFOX began to provide FDIC insurance for bitcoin investors.[vii]
· Fraud Risks
Fraud risks are also a potential threat as there are attempts to sell fake Bitcoin. Ponzi schemes and price manipulation are other fraud risks to be cautious of. Generally speaking, if something sounds too good to be true involving Bitcoin, it probably is.[viii]
· Market Risk
The value of Bitcoin can fluctuate wildly, as you may have recently seen in the news. As little as a single celebrity tweet (thanks, Elon!) can send the value of Bitcoin soaring.[ix] But while Bitcoin surged over most of last month, you should not be surprised if you see the value drop significantly either. If fewer people were to accept Bitcoin as a currency, it could lose significant value in a hurry.
15 Minutes of Fame? Or the Currency of the Future?
Bitcoin and other cryptocurrency are certainly having their moment in the spotlight, and they may veritably just be the way of the future. But like any new innovation, there are lots of risks involved. If you’re feeling some Bitcoin FOMO and want to jump on the bandwagon, we recommend calling your advisor before taking the leap.
If you would like to learn more about investing in Bitcoin or other cryptocurrencies, feel free to reach out to us today. We are always here to keep our clients and extended network informed as these new developments unfold.
[i] https://www.trality.com/blog/best-cryptocurrencies-to-invest-in 10 March 2021
[ii] https://www.forbes.com/sites/billybambrough/2021/03/03/as-bitcoin-suddenly-surges-over-50000-the-price-of-these-cryptocurrency-stocks-is-soaring/?sh=78a164903665 10 March 2021
[iii] https://builtin.com/blockchain 10 March 2021
[iv] Ibid.
[v] https://www.investopedia.com/tech/what-happens-bitcoin-after-21-million-mined/ 10 March 2021
[vi] Ibid.
[vii] https://www.bloomberg.com/news/articles/2019-05-14/wild-crypto-market-s-traders-get-something-new-fdic-protection 10 March 2021
[viii] https://www.sec.gov/investor/alerts/ia_virtualcurrencies.pdf 10 March 2021
[ix] https://www.forbes.com/sites/ronshevlin/2021/02/21/how-elon-musk-moves-the-price-of-bitcoin-with-his-twitter-activity/?sh=6e8a60975d27 10 March 2021
All matters discussed in this article are for informational purposes only. Opinions expressed are solely those of URS Advisory and staff. The information discussed has been derived from sources believed to be reliable but is not guaranteed as to accuracy and completeness and does not purport to be a complete analysis of the materials discussed.
Advisory services are offered through URS Advisory LLC dba URS Advisory, a Registered Investment Advisor in the State of Florida (CRD# 289892). Insurance products and services are offered through JEL Enterprises, Inc. dba URS Insurance, an affiliated company.
Disclaimer: Advisory services are offered through URS Advisory LLC, a Registered Investment Advisor in the State of Florida. Insurance products and services are offered through URS Insurance, an affiliated company. URS Advisory LLC and URS Insurance are not affiliated with or endorsed by the Social Security Administration or any government agency. Investing involves risk including the potential for loss, and past performance is no indication of future results. Opinions expressed herein are solely those of URS Advisory. All written content is for information purposes only. It is not intended to provide any tax or legal advice or provide the basis for any financial decisions. Material presented is believed to be from reliable sources; however, we make no representations as to its accuracy or completeness. All information and ideas should be discussed in detail with your financial adviser or qualified professional before making any financial decisions.Return to All Articles