Should You Invest in Cryptocurrencies? – Forbes Advisor

Cryptocurrencies are taking the world by storm. Since 2009, when the first cryptocurrency, Bitcoin, was launched, the crypto world has seen incredible highs and frightening lows.

The truth is, cryptocurrencies are highly volatile assets. Investors need to understand that owning cryptocurrencies involves significant risk to their portfolio. However, for investors who understand how to manage risk, cryptocurrencies can offer significant opportunities.

Is investing in cryptocurrencies safe?

Cryptocurrencies have brought huge profits to some investors, but also huge losses to others.

William Prokasky, CFA, an assistant professor of finance at Texas A&M University-Kingsville, said new investors should stay away from cryptocurrencies, but noted that experienced investors who understand how to deal with the risks may find room for them in their portfolios.

“If you’re building a broad portfolio and you want to add crypto to the 5% or 10% of your portfolio that you have set aside for alternative assets, that might be OK,” Prokasky said.

Bitcoin and Ethereum are the two largest cryptocurrencies by market cap and are more established than many others, making them a safer investment for most investors.

“If you go for a more mainstream option like Bitcoin or Ethereum, you have a little bit more security,” says Lauren Niestrad, CFP/CFA, senior portfolio manager at Truepoint Wealth Counsel.

What the SEC is saying about cryptocurrencies

The SEC has been skeptical of cryptocurrencies. In an interview with Yahoo Finance, SEC Chairman Gary Gensler said crypto companies need to “comply” with existing laws.

These comments came on the heels of the FTX debacle at the end of 2022.

Gensler hopes the SEC can provide consumer protections for crypto-holding companies if they choose to become lending companies.

“There is no reason to treat the cryptocurrency market differently just because different technology is used. We should be technology neutral,” Gensler said in an April 2022 speech.

This means that not only new laws and regulations being debated by Congress, but existing regulations too could affect the way cryptocurrency exchanges and other companies do business.

Risks of investing in cryptocurrencies

Investing in cryptocurrencies involves several risks, including loss of capital, government regulation, fraud and hacking.

• Loss of capital. Mark Hastings, a partner at Quillon Law, warns that investors need to be careful in the unique financial environment of cryptocurrencies or risk significant losses. This is a risk with any investment, but cryptocurrencies' volatility makes it an even bigger risk factor. With Bitcoin down more than 60% in the past 12 months, these losses could easily amount to a significant portion of the original investment.
• Government regulations. According to Michael Collins, CFA, professor of financial planning at Endicott College, many governments have yet to fully regulate the use and trading of cryptocurrencies, and it can be difficult to know what to expect in terms of legal and financial risks. Some have argued that cryptocurrencies should be made illegal in the United States. This is probably an unlikely scenario, but it's certainly possible, as it's already happened in China.
• scam. As with any unregulated industry, fraud is rampant in the crypto world, with Hastings saying “2022 has seen a surge in crypto scams, with thousands of investors losing money due to a lack of regulatory oversight of the industry.”
• hacking. Hacks are common in cryptocurrency: According to Chainalysis, more than $3.2 billion in cryptocurrency was stolen in 2021. While many exchanges offer private insurance, if you lose your cryptocurrency in a hack, you may not have a way to get your investment back.

Introducing cryptocurrencies

As of this writing, Bitcoin is priced at around $17,000, well below its November 2021 high of $65,000.

However, Bitcoin was initially hailed as a form of electronic money, not a long-term investment, and for this to work as expected, cryptocurrencies like Bitcoin need to be able to be used to buy goods and services.

However, while there are more than 22,000 cryptocurrencies in circulation, only a few are widely accepted for purchasing goods and services.

It was estimated that around 2,300 US businesses accepted cryptocurrencies for payments in late 2020. In 2019, there were over 35 million businesses in the US, so this is a tiny fraction of the businesses that accepted cryptocurrencies.

Will cryptocurrencies become the new global currency?

The excitement surrounding cryptocurrencies has led many proponents to tout their potential to become a global currency.

“I don't see how the government would allow a competing currency of that size,” Prokasky said. “An international currency has to be very liquid and deep. There's nothing that can compete with the U.S. dollar.”

Money is a tightly regulated and controlled asset. As evidenced by scandals such as Terra Luna, Celsius and FTX in 2022, cryptocurrencies in their current form can cause significant damage to personal finances. The majority of world governments will not allow their financial systems to take such risks.

“I think that's years away,” Niestrat said, “and there's some speculation there. It's not a certainty.”

Are cryptocurrencies a hedge against inflation?

Those who still believe that Bitcoin and other cryptocurrencies could be a hedge against inflation are simply not paying attention.

According to the U.S. Bureau of Labor Statistics, core inflation rose by more than 7% year-over-year in November 2022. Bitcoin fell by more than 65% in the same period.

“Cryptocurrencies have failed the test as an inflation hedge. If it were possible to give them an F-, that's how they performed,” Prokasky said.

Cryptocurrency and Taxes

Investors must pay capital gains tax on any income they make from cryptocurrencies, which means that whenever cryptocurrency is transferred, it is subject to tax, including mining and staking.

Capital gains taxes are around 15% but can be as high as 20% or more.

To make purchases with cryptocurrency, investors typically need to convert it into fiat currency, which makes using cryptocurrency for most purchases taxable and more expensive than buying the goods with cash.

Is cryptocurrency a good long-term investment?

Cryptocurrencies need widespread adoption to gain long-term value, and they face significant headwinds.

“We believe there is innovation and practical utility in the underlying technology of blockchain, but the risks are too great until it is separated from unregulated monetary gambling,” said Andrew Rosen, CFP, president of Diversified LLC.

But more speculative investors might be willing to take a chance on this one.

These investors may or may not see short-term gains, but that doesn't mean the right cryptocurrency won't deliver huge gains in the long run. Of course, it's entirely possible that an investor's total cryptocurrency holdings could go to zero.

Should you invest in cryptocurrencies?

The final decision on whether or not you should invest in cryptocurrencies can only be made by you.

But whatever decision you make in that regard, it's worth doing your due diligence, understanding the investment thesis for each coin and even speaking with a financial advisor.

“There are other assets you can speculate on. It doesn't have to be cryptocurrency, but there is a role for cryptocurrency in the long term and if you believe in blockchain technology, there is a case to be made for it,” Prokasky said.