By Dr. James M. Dahle, WCI Founder
It's been a while since I wrote about cryptocurrency and cryptoassets. The last time I did, they were flying high. In 2022, it subsequently crashed. Industry leader Bitcoin dropped 70% with other crypto projects dropping 80%, 90%, or more in value. It has been one of the more brutal “crypto winters” that investors and developers in this space have suffered through, and that's not even counting the FTX meltdown. Nobody knows when, or even if, crypto will soar again.
But if you think it's a great asset to hold for the long term, the end of 2022 (when I originally wrote this post) was a much better time to buy than in 2021. And at the beginning of 2023, it still might be.
This is where things stood at the end of 2022.
As of January 2023, things were slightly better with Bitcoin at about 23,000, and the other three had similar (but slightly lower) prices than what the charts are showing.
Pros and Cons of Crypto
Cryptocurrency is a broad and diverse asset class that comprises everything from the well-known Bitcoin cryptocurrency to the latest johnny-come-lately blockchain project started by a college freshman. Most of these projects aren't going anywhere from an investment perspective. None of these coins, tokens, or currencies produce any earnings, rents, interest, or dividends. They are, by definition, speculative assets. That's the main reason I don't invest in any of them, and I recommend that readers limit their investment to 0%-5% of their portfolios. Whether you choose to invest, it's a good idea to understand the pros and cons of doing so from an investment standpoint.
More information here:
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Pros of Cryptocurrency Investing
First, we'll talk about the pros of crypto.
#1 You Might Get Rich
Let's start with the elephant in the room. It's entirely possible to get fantastically wealthy by successfully investing in crypto. Buy before the market realizes something is valuable, hold on to it while the market realizes the value, watch the asset price soar as the crowds pile in, and escape before the inevitable collapse. Rinse and repeat successfully, and there is little that can compare in the investment world. Obviously, identifying the successful projects in advance is difficult—and even more so when the timing of the market is involved.
The other approach is to simply buy and HODL (hold on for dear life) in hopes that the long-term trajectory is up. While that isn't the case with the vast majority of crypto projects, it's too early to rule out the possibility for some of the longer-term, well-known ones. The Bitcoin white paper came out in 2008. Even though Bitcoin is down more than 60% from its peak, it is still up 61X from its 2015 price. And 2015 wasn't exactly early for Bitcoin. I knew about it for at least 3-4 years before that. Imagine you put $100,000 into it in 2015 and held it until today. You would have $6.1 million. That's enough to retire. If you had sold last year, you'd have $21 million. That's enough to retire, set up your kids for life, and start a charitable foundation.
I don't recommend speculating on these assets, but I certainly understand why people do so and you should understand it, too. If you decide to invest, this is how to invest in cryptocurrency.
#2 You Will Learn More About the Space
Really want to learn about this stuff? Put some money into it. Not a lot, but enough that you care a little more than you otherwise would. Think of it as tuition. You might even get your tuition back. Maybe you'll even get more than your tuition back. But I can guarantee that you'll learn some lessons if you put money into it. You'll learn about crypto investing. You'll learn about yourself and your strengths and weaknesses as an investor. You might even get to learn about scams and market crashes and other fun stuff.
#3 You Can Smuggle Money
You know what I find to be the most attractive use case for crypto? Leaving a part of the world where bad things have happened suddenly and taking your wealth with you. You may have noticed that the US government (among others) takes a keen interest in any sizable transfers of money. Even if you want to leave or enter the country with cash, you're supposed to declare any amount of $10,000 or more. And those are supposed to be the good guys. People have been fleeing war-torn countries for millennia with nothing but the shirt on their backs. Imagine if they could bring their shirt and all of their wealth too? Pretty cool, right? Even just taking 5% of your wealth would give you a huge headstart over your fellow refugees in your new locale.
#4 Capital Gains Tax Treatment
I'm not sure how it happened, but crypto scored in this department. Unlike precious metals, where gains are taxed at the higher collectibles rate, cryptoasset sales can qualify for the lower long-term capital gains (LTCG) tax rates.
#5 No Wash Sales
But wait! It gets better. Not only do you get LTCG treatment, but you can also tax-loss harvest cryptoassets. Normally, when you tax-loss harvest stocks or mutual funds, you can't buy them back for 30 days or you create a “wash sale” and your loss is disallowed. Not the case for crypto. You can buy it back immediately and you still get to use that loss on your taxes. Congress will probably fix this loophole eventually, but for now, it is wide open.
#6 Low Correlation with Other Asset Classes
While 2022 wasn't kind to stocks, bonds, assets, crypto, or real estate (at least the publicly traded version), crypto has pretty low correlation to the more traditional investment asset classes. If you can build a portfolio composed of asset classes where each has a high long-term return and low correlation with the others, you have a recipe for success. The overall volatility will be muted, and the overall returns will be boosted. The jury is still out on the long-term returns for crypto, but there is plenty of evidence suggesting correlations are quite low most of the time. That's a good thing for an investor.
#7 Blockchain Security
Blockchain is a crazy cool invention, because it allows for decentralized records of ownership. That feature actually makes it harder to steal assets in some ways because everyone can see who it went to! That's way better than marked bills in a bank vault.
#8 24-Hour Trading
Not sure this is really a pro, but you can trade cryptoassets 24/7/365, four times as often as the typical security markets.
More information here:
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Cons of Cryptocurrency Investing
Naturally, there are plenty of cons when it comes to cryptocurrency.
As mentioned above, almost all cryptoassets provide no income of any kind. These aren't companies. They're not making anything. There are no earnings. You're hoping someone will pay you more for the asset later. You're entirely reliant on the moods of the market for your investment return.
Whether you believe in the long-term returns of a crypto asset, you'll need to be able to stomach massive volatility to be successful with it. Does it bother you when the value of your investment drops 30%, 50%, 70%, or 90%? I know it does me. That's another big reason I don't invest. Not only would I be likely to sell out at market lows, but I'd be likely to sell out at market highs.
#3 Long Steep Learning Curve
These assets are complicated. By comparison, they make a typical bond or mutual fund look simple to understand. The old adage is, “Don't invest in anything you don't understand.” I suspect only a tiny fraction of cryptoasset investors really have more than a superficial understanding of their investment. The real diehards here tell me it took them 1,000 hours of reading and studying about this stuff just to get started. I don't know about you, but I don't have a spare 1,000 hours sitting around.
#4 Counterparty Risk
When you buy a mutual fund in a brokerage account at Vanguard, it sits there and gets protected (up to $500,000) from fraud by the Securities Investor Protection Corporation. If you buy some Bitcoin and let it sit there at Coinbase and then Coinbase goes out of business (counterparty risk), you're probably not going to get that Bitcoin back. While exchanges might carry some business insurance, there is no FDIC or SIPC backing it up. Your alternative is to pull your asset off the exchange into a cold wallet. There is some inconvenience to that. There are plenty of exchanges out there that are brand-new businesses, often with large amounts of leverage. In July 2022 alone, two exchanges (Voyager and Celsius) declared bankruptcy. Investors with funds there can't get their money back now and probably won't get all of their money back ever. Even if the underlying cryptoasset was fine, the investor still gets hosed.
#5 Manias and Scams
Speaking of getting hosed, crypto investing is the Wild Wild West. There are manias and, perhaps more importantly, plenty of scammers running around out there. Those folks don't get attracted in to the Treasury bond market, but if you're going to be around crypto, you'd better have your head on a swivel.
#6 Regulatory Issues
Governments are still trying to figure out what to do about cryptoassets. Some countries have banned Bitcoin outright; others have a de facto ban. As the rules change over the years, they can have serious effects on the value of your investment.
Most cryptoassets have only been around for a few years. Even Bitcoin is basically new since the global financial crisis of 2008. Plenty of very smart investors see this entire space as one big tulip mania bubble, and there's a decent chance they're right. Long-term returns may be poor or even negative. We just don't know. While a few winners are likely to emerge, plenty of people will lose their shirts along the way.
#8 Scalability Issues
Lots of the cool things that you can do with cryptocurrency can't be done by everybody at once. Slow transactions cost money and subtract value. This is a serious limiting factor in the everyday use of cryptoassets of any kind. Bitcoin was supposed to be an everyday currency long before now. I still can't use it at restaurants, grocery stores, gas stations, or even most online retailers. The tax treatment and volatility are certainly limiting, but the scalability issue is probably a bigger hurdle to overcome.
#9 Security Risks
While the blockchain adds some security (especially in securing an asset from a centralized government), there are plenty of other risks when it comes to crypto. You can lose your key (something like 20% of Bitcoin has already been lost) and it can be stolen due to hacking or phishing with little recourse.
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What's Going to Happen with Crypto?
I have no idea. But if I was forced to guess, I would expect that it recovers its price at least somewhat along with the stock market. As prices rise, investors will pile in all over again just as they have after previous severe downturns. There are certainly plenty of almost religiously diehard Bitcoin believers to keep a floor under its price at some level. They will go to their grave owning their coins just knowing recovery is always right around the corner. However, the idea that the price can fall no further than the production cost of a Bitcoin was challenged this time. It turns out that production costs can and do go down. In 2022, they fell from $20,000 to $13,000.
Crypto asset investing has its pros and cons. There are plenty of popular cryptocurrencies out there. For me, the cons outweigh the pros. If that's not the case for you, please invest intelligently and in a very limited way. This is an easy place to get burned. Before you get too excited, ask yourself “Should I Invest in Cryptocurrency?”
What do you think? What do you see as the pros and cons of crypto investing? Is there a price at which you would buy Bitcoin, Ethereum, or others? Comment below!