The recent eye-popping gains in Bitcoin and other cryptocurrencies are hard to ignore, but the proposition to invest in a Cryptocurrency IRA already may not be as attractive as it sounds.
If you’ve been watching Bitcoin prices lately, you already know they’ve made a record-setting run. As of this writing, a single Bitcoin is valued at almost $1,300, more than an ounce of gold. To put things in perspective, Bitcoin values were in the $300 — $400 range for much of 2015.
As of this writing, the value of a Cryptocurrency IRA is over $11,500 – that’s almost 10 times higher than at the beginning of the year. Those who invested in Bitcoin years ago (or even in March of 2017) are likely rejoicing. But, should you join them?
Continue reading to learn more about cryptocurrency, how it works, and why this investment might be worth skipping, despite its high returns.
Drawbacks to Cryptocurrency Investing
Cryptocurrency is a digital form of currency used by online firms and big businesses worldwide. One of the biggest advantages of cryptocurrency is that the currency can cross borders easily — facilitating international trade.
For the purposes of investing, cryptocurrency is similar to any other currency (or commodity) investment. This means, when it comes to your investment return, cryptocurrency faces the same uphill battle as investing in:
- agricultural products
- fine art
In other words, at any given time, any form of cryptocurrency is worth whatever the market says it’s worth. While this isn’t a problem in itself, investing in cryptocurrency does pose some specific challenges.
As appealing as investing in cryptocurrency sounds — and despite the recent run-up in price — there are at least two fundamental problems with investing in cryptocurrency right now:
PROBLEM #1: YOU LOSE MONEY AFTER INFLATION (NEGATIVE REAL RETURNS)
When you invest in cryptocurrency (or gold, or oil, or other commodities, or any other currency, or fine art), you are betting the farm on price appreciation alone. Or rather, you’re betting that the price of cryptocurrency will go up compared with the U.S. dollar.
What this means is, investing in cryptocurrency is different from more conventional investments like stocks, bonds and real estate. That’s because conventional investments offer the chance to generate cash.
As an example, stocks are a slice of business ownership. Businesses exist to earn a profit. As an owner of that business, you are entitled to a fraction of that profit. That profit can either be re-invested into the business (to increase the value of the business) or paid to investors as dividends. Either way, a stock generates cash — ultimately enriching those who own shares.
Not only must your investment appreciate at the rate of inflation, but it must also go above and beyond inflation to make up for the transaction costs.
Trust me when I say this is rarely the case! Most commodities increase at the rate of inflation. Furthermore, currency doesn’t increase in value at all — because that’s exactly what inflation is — a decrease in the value of currency!
On average, economies grow. A growing economy can raise the demand for goods and services. This can cause prices for said goods and services to increase.
Moreover, entities issuing currency usually print even more currency (View: Fiat Currency). This devalues that currency, requiring more of the same currency to be required for the same good or service.
These two factors – a growing economy and the printing of more money – can cause inflation. Therefore, an investment in currency, by its nature, should not be able to grow with inflation.
Not only does your investment in currency lose money because of inflation, but your investment also loses from the bid/ask spread – the price of buying into a different currency.
Commodities’ returns just about equal inflation over the year, but that’s before fees. Proponents of cryptocurrency investing make the case that cryptocurrency will indeed grow above inflation.
The same also claim that it is a “deflationary currency.” And so far, that looks to be the case. Of course, with only a short timeline since cryptocurrency has been around, it may be hard to make that case definitively. This is unlike stocks, which have been around for centuries.
In short, cryptocurrency and similar investments are at a big disadvantage when it comes to generating an investment return. Cryptocurrency doesn’t generate cash like stocks, bonds and rental real estate do — and they have the added challenge of never even being able to keep up with inflation!
PROBLEM #2: MEAN REVERSION
Mean reversion is a fancy way of saying: What goes up, must come down — and vice versa. All investments are subject to mean reversion, and cryptocurrency is no exception.
Mean reversion itself isn’t a bad thing, but it’s still worth noting when it comes to investing in cryptocurrency, specifically. As mentioned above, commodities provide an investment return at just about the rate of inflation — before fees.
Moreover, commodities depend upon price appreciation alone to provide an investment return. This is because commodities do not generate cash.
So, if you are going to get an investment return from cryptocurrency, you don’t want to be buying at a market top. However, recent run-ups in price suggest that it’s possible we are at the top of the cryptocurrency market — or, at least, on the way.
Most of the time, you’ll be a lot better off if you choose a long-term investment strategy that isn’t quite so volatile. You should also diversify as much as you can; this way, you won’t lose your shirt if one particular investment falls apart.
If you choose to invest in cryptocurrency in spite of this advice, just know you’re doing so at your peril. The best thing you can do is limit your investment to an amount you can afford to lose, then brace yourself for a long and bumpy ride.
A Final Warning on Cryptocurrency: Look Out for Security Holes
Yes, cryptocurrency is a volatile investment that may very likely be a bubble. For that reason, you could lose most (all?) of your investment.
However, in addition to cryptocurrency being a risky investment for all the reasons that investments can be risky (i.e., volatility), Cryptocurrency investing suffers from additional security challenges that traditional investments (such as plain vanilla stocks and bonds) do not.
Instead of the usual investment risk of your principal decreasing in value, with cryptocurrencies, you may lose your crypto assets entirely. In addition to price volatility, investors in crypto assets have lost money because of:
- outright theft,
- imperfect software (i.e., “bugs”), or even
- misplacing login information
The Positive Side to Cryptocurrency Investment
In order to reach your financial goals, you must create a diverse portfolio. Diversification helps reduce risk and maximize safer earnings.
A Cryptocurrency IRA is a new asset for investors to consider including as part of their overall diversification strategy in their portfolios.
Although it is one of the riskier investments today, many believe it has a lot of room to grow and only represents a fraction of other financial assets.
Like any asset class, it’s important to know the risks and understand the technical and fundamentals associated with the assets, including any correlation to other asset classes.
Many believe that cryptocurrency in an early pioneer that represents an emerging currency market based on blockchain technology. Early investors who believe in the growth of the cryptocurrencies market are speculating that it will continue to grow over the long term.
New Government Regulations for Cryptocurrency IRA’s
CME Group announced its plans to launch cryptocurrency futures at the end of 2017 pending all regulatory review periods.
CME Group is a leading marketplace for derivatives managing 3 billion contracts worth about $1 quadrillion annually and their entry into the space marks a significant regulation milestone for cryptocurrencies.
Their news also follows the SEC’s attempt to crackdown on ICO’s. ICOs are unregulated methods of raising funds for start-ups and they have become increasingly popular, often raising tens of millions of dollars overnight.
The SEC is looking at ICO’s as securities and, as many scams and lawsuits are beginning to proliferate in the space, many are expecting the SEC to announce new regulations very soon.
Analysts believe the government’s increased regulation and oversight of digital currencies will reduce the risk and volatility, thus enticing larger institutional investors and financial firms to jump into the space.
New Opportunities Are Creating Substantial Gains
Investing in digital currency in channels outside of cash purchases has been increasing, especially by the option of adding cryptocurrencies to an individual’s retirement account.
One of the leading companies in the industry is BitcoinIRA.com and their COO, Chris Kline, stated in an interview with Huffington Post, that demand for Cryptocurrency’s in an IRA has “exploded.” He adds that their customers were seeing incredible return this year as a result of the increased price.
Bitcoin has increased 600% in 2017 alone and many alternative cryptocurrencies, such as Ethereum and Litecoin, have seen similar extraordinary gains.
“Many believe that a Cryptocurrency IRA will be the next great technological innovation of their lifetime” Mr. Kline added. “They’re seizing the opportunity now as a way of accelerating their retirement goals before the price the rest of the industry catches up and the prices potentially go much higher.”
Reasons to Invest in Cryptocurrency Through an IRA Custodian
The most obvious reason to use a Cryptocurrency IRA to invest in digital currencies, as opposed to simply buying them through an exchange, is for the tax advantages.
For as long as your money stays in the IRA, you won’t pay any tax on profits your investments earn. You only may have to pay tax when you eventually take a distribution.
On the same topic, a self-directed Cryptocurrency IRA can be structured as either a Traditional or Roth IRA, so you can choose whether you want your tax deduction now or if you would rather have tax-free withdrawals in retirement.
The same rules apply as with a conventional IRA, in terms of contribution limits and withdrawal restrictions.
Another advantage is the ability to buy an unlimited amount of digital currency almost instantly. Exchanges tend to set limits for most customer but with a Cryptocurrency IRA this isn’t an issue.
Conclusion: Should You Invest in a Cryptocurrency IRA?
While the vast majority of anyone’s retirement assets should be in precious metals, land, and similar physical assets of high intrinsic value, there’s nothing wrong with speculating with a small portion of your savings – as long as it’s with money that you can afford to lose if things don’t go your way.
After all, Bitcoin has risen from roughly $200 to nearly $4,000 in just a few years, and it’s certainly not impossible for the opposite to happen. It has been speculated by many financial investment experts that Bitcoin could potentially be worth $1 million someday, but that would also mean that there is a slight chance that it could be worth far less than it is now.
You must thoroughly understand cryptocurrencies and the risk involved with them. “A Cryptocurrency IRA is appropriate for someone who is educated about digital currencies and understands what they’re getting into,” says Kline. You open your Cryptocurrency IRA with a reputable company.
As Harris says, “Buyer beware. If you decide to invest in digital currencies, be sure to work with a reputable company — preferably one registered with the Treasury as an MSB [Money Services Business].”
In a nutshell, a Cryptocurrency IRA can work as a small complement to an existing, well-rounded retirement portfolio, but it’s important to understand the pros and cons of self-directed IRA’s, as well as to have a basic knowledge of cryptocurrencies and the risks involved with investing in them.
If you are ready to invest in a Cryptocurrency IRA, view our List of Best Cryptocurrency IRA Companies.
Do you have any questions about whether it is worth investing in a Cryptocurrency IRA? Ask below!