Key Takeaways
- Consider whether crypto aligns with your portfolio goals, risk tolerance, and personal values before purchasing.
- Crypto is highly volatile and lacks the regulatory protections of registered securities. It’s also not insured by the FDIC or SIPC.
- As a digital asset, crypto requires specific security and tax considerations.
Many of the assets we trade today have long histories. Gold, for example, has been used in trade since around 560 BC in the ancient Kingdom of Lydia. The first modern stock exchange was established over 400 years ago in Amsterdam, and ETFs have been traded for more than 25 years. In contrast, cryptocurrency has only been around for just over a decade. Bitcoin, the first decentralized cryptocurrency, was mined in January 2009. While revolutionary in many ways, the industry is still young, and the regulatory landscape remains uncertain. As a result, the market is often volatile, affected by factors such as crypto exchange failures and high-profile security breaches.
Wondering if crypto is right for you? Start by asking yourself these five key questions:
- Do you understand the crypto landscape?
- Are you comfortable with volatility?
- Can you handle the investment risks?
- Do you know how to store your crypto securely?
- Are you aware of the tax implications?
Let’s explore what you should consider for each of these questions.
Get Educated
When you hear about people investing in crypto, it may seem like a single asset, such as a stock or bond. In reality, “crypto” refers to a wide variety of assets with different purposes, including Bitcoin, Ethereum, and over 19,000 other cryptocurrencies—many of which are untested and unlikely to last.
Before diving in, it’s important to get educated about this fast-evolving market. For instance, you should understand blockchain technology and decentralization. If you’re interested in Bitcoin, be familiar with concepts like cryptographic hashes and mining, as they are integral to its function.
In addition to the basics, stay updated on the latest crypto news. The market moves quickly, and new developments occur almost daily. Government regulations are also changing, and each decision could affect how crypto is treated legally.
Once you’ve learned how the technology and market dynamics work, ask yourself: Do you genuinely believe crypto will hold value in the long term? If your answer is “no” or “I’m unsure,” it might not be the right investment for you. This is an important question because volatile markets may challenge your conviction.
Prepare for Volatility
There’s no sugar-coating it: Crypto is highly volatile and may be more prone to market manipulation than traditional securities. Crypto holders don’t benefit from the same regulatory protections as those holding registered securities, and the regulatory environment remains uncertain.
Moreover, crypto is not insured by the FDIC or SIPC, meaning you should only invest money you can afford to lose.
To understand the volatility, consider Bitcoin, the oldest and largest cryptocurrency by market cap. Bitcoin’s price regularly experiences double-digit drops and rallies, sometimes within the same week. For example, if you bought a Bitcoin at $7,000 during the COVID-19 market dip in March 2020, it would have surged to $69,000 by November 2021—a gain of over 850%. However, by June 2022, it had dropped to $17,500, a loss of over 70% from its November peak.
Ethereum has also experienced extreme volatility. In March 2020, it traded around $120, then skyrocketed over 3,900% to $4,867 by November 2021. By June 2022, it had fallen to $880.
Other cryptocurrencies, like Terra’s LUNA token, have experienced even more dramatic swings. LUNA’s price plummeted from nearly $120 to almost nothing in May 2022 after its financial foundation collapsed. Dogecoin has also seen wild fluctuations, including a 42,000% gain from March 2020 to November 2021, followed by a 90% drop by June 2022.
Despite the 2022 bear market, those who invested in crypto before 2020 may still be in profit. However, many investors have also faced losses. Time will tell if cryptocurrency prices become less volatile over time, but for the foreseeable future, you should expect continued fluctuations.
Manage Risks
Given the uncertainty surrounding crypto, it’s best to approach it with a defensive mindset. While there’s potential for substantial gains, the risks can also be sharp and sudden. Additionally, crypto may have a higher likelihood of losing value completely compared to many other assets. Therefore, limit your crypto investment to an amount you can afford to lose.
If you’re aiming to diversify your portfolio or saving for a short-term goal, crypto may not be the best choice due to its unpredictability.
If your crypto holdings grow to a larger portion of your portfolio than intended, consider reallocating some of those gains into more stable asset classes. This can help reduce the overall volatility of your investments.
Get Smart About Security
A key consideration when buying crypto is ensuring it’s stored securely. If you don’t want to delve into the complexities of crypto cybersecurity, it may be easiest to keep your coins with a trusted custody provider that offers robust and audited security measures. These platforms typically provide more user-friendly security options, especially for beginners.
Alternatively, if you prefer a more hands-on approach, you can choose to manage and secure your crypto yourself. This involves purchasing crypto on a trading platform and transferring your holdings to a private digital wallet or a physical cold wallet (a USB-like device used for offline storage).
While this method offers more flexibility in how you use your crypto, it also means you are responsible for securing your assets. If your private or exchange accounts are hacked, if you make an error transferring your coins, or if the platform you use goes bankrupt, you may lose access to your funds permanently.
Don’t Forget Taxes
On the surface, crypto is taxed similarly to stocks. Selling crypto at a profit triggers capital gains tax, while selling at a loss may allow for deductions.
However, there are additional complexities to consider. For example, paying for goods and services with crypto may trigger capital gains or losses. Tax rules are also evolving for crypto earned through mining, staking, or received via airdrops or hard forks.
Because the industry is so new, tax regulations can change rapidly. It’s advisable to familiarize yourself with the basics of crypto taxes before purchasing. While many tax software platforms are incorporating crypto calculations, you may want to consult a tax professional to ensure your filings are accurate.
Summing It Up
Crypto is an exciting but speculative asset with high volatility. It’s not protected by the same regulations as traditional securities and isn’t insured by the FDIC or SIPC. Before investing, assess whether it fits your long-term goals and risk tolerance, and remember to limit your exposure to an amount you can afford to lose.
Make sure you understand your security options, whether you choose to store your crypto with a trusted provider or manage it independently. Additionally, be aware of the tax implications and seek professional advice if needed.
Above all, keep risk management in mind as you navigate the crypto market to minimize stress in both the short and long term.