One of the most popular topics currently in business news is cryptocurrency. During the COVID-19 pandemic, cryptocurrency options like Bitcoin and Dogecoin have become mainstream, with Bitcoin value skyrocketing by 500% over the past several months and it has no intention of going away.
To a new investor or a seasoned business guru, cryptocurrency can still be challenging to understand. To answer some popular questions about cryptocurrency, we turned to our friend, JJ Montanaro at USAA to give us a look into how it all works.
MSF: What is Cryptocurrency and how does it work?
JJ: It’s a digital currency and exists entirely online. It’s also different because it’s a peer-to-peer medium of exchange that doesn’t require a middleman like a bank or government. Blockchain technology is what makes it secure and allows the crypto system to work. This process also mathematically limits the amount of the digital currency that exists. Bitcoin, for example, is mathematically limited to 21 million units existing in the marketplace. This limit makes the currency function more like a commodity than a traditional money system.
MSF: Are there benefits to buying and selling cryptocurrency?
JJ: As a currency, it holds the potential to act as an alternate currency across geographic borders, fast and with lower transaction costs. You don’t need a bank account to take care of business and theoretically the value of the currency is not impacted by government policies or actions. Transactions conducted with bitcoin, while not anonymous, offer more privacy than traditional currencies. As a currency, you must also factor in the question, “Where is it accepted?”
As an investment, cryptocurrency is more market speculation than traditional investment. Pricing changes continuously, so there is a potential for buying it at a lower price and selling it at a higher one in the future. The opposite is true as well. Prices change fast with cryptocurrency as compared to other traditional asset classes like stocks or bonds. Cryptocurrency may be more volatile and should be reserved for experienced individuals considering whether to invest in it or not. The risks involved with virtual currencies are significant as they are subject to non-traditional supply and demand pricing, information is technical and difficult to consume. There are regulatory considerations as well as the risks of fraud or other cybercrimes.
MSF: Is cryptocurrency even legal?
JJ: In the U.S. cryptocurrencies are legal. The IRS defines them as “a digital representation of value that functions as a medium of exchange, unit of account, and/or a store of value.” The U.S. Securities and Exchange Commission considers cryptocurrencies to be securities.
MSF: Is cryptocurrency a viable investment?
JJ: That depends on how you define viable and how you choose to invest. Recently, it has become easier to buy and sell cryptocurrency through exchanges like Coinbase and through platforms offered by firms like Robinhood and Paypal. Cryptocurrencies have been very volatile and subject to significant valuation swings. Over the last five years, the value of a single Bitcoin has skyrocketed from around $600 to around $50,000. However, it has also seen 50% changes in prices during short periods of time too. Bitcoin was at its current peak (approximately $60,000) in April of 2021 and was worth around $30,000 in July. Cryptocurrencies could be a good tool to diversify your portfolio, but merit caution. For example, accounts or exchanges are subject to hacking and there is no FDIC or SIPC to back up your cryptocurrency investment.
MSF: I’m ready to buy crypto! How can I do so?
JJ: You can buy crypto through one of the many crypto exchanges like Coinbase or Kraken. You could buy a stock involved in space like a cryptocurrency miner or even the stock of a crypto exchange. Finally, you could buy a cryptocurrency itself through a platform like Paypal or Robinhood. However, with Paypal or Robinhood you can buy or sell the cryptocurrency but don’t actually own the cryptocurrency and currently don’t have the ability to transfer or exchange it outside of their platforms.
MSF: How do I convert my crypto to hard cash in my wallet?
JJ: The cryptocurrency exchanges allow you to turn your cryto into cash and transfer it to your bank account. There are thousands of crypto ATMs that will also allow you to cash out if you’re willing to endure some significant transaction fees.
MSF: Is money made from cryptocurrency taxable?
JJ: Uncle Sam is not going to miss out on this type of opportunity, so, yes! Here’s a link to the IRS FAQs on the subject. In a nutshell, the cryptocurrency is treated as property for tax purposes and any crypto you held for one year or less is treated as a short-term capital gain, essentially taxed as income.
MSF: Can I invest in crypto within my 401(K) or other retirement account?
JJ: That’s a question to ask your plan provider or IRA custodian. There are IRA custodians that offer the ability to hold cryptocurrency in your IRA, but that’s the exception as opposed to the norm.