Cryptocurrency Is Risky. 5 Things Every Crypto Investor Should Know

Person standing among animated bitcoins Robert Rodriguez/CNET

Cryptocurrency is quickly becoming a red-hot tool for some people bent on making money through investing in digital coinage. Crypto is also controversial and can be wildly volatile. To some, bitcoin, stablecoin and NFTs represent a step forward for investors — a kind of “Money 2.0.” Advocates point to crypto’s potential to democratize finance and power the metaverse.

To others, cryptocurrency is simply a new, digital form of an old con primed to swindle and scam. Still others consider the whole endeavor an empty bubble, destined to burst.

In simple terms, cryptocurrency is a digital token whose ownership is recorded on a blockchain, a distributed software ledger that no one controls — this is designed to make it more secure, in theory. Bitcoin and ethereum are the two most widely known flavors of crypto, but more than 18,000 tokens are traded under different names (Dogecoin is one infamous example).

Despite the seesawing prices and lack of regulation, cryptocurrency is moving mainstream as the next financial frontier. Developments like President Joe Biden’s desire to explore a digital US dollar to four multimillion dollar Super Bowl ads underscore a growing desire from powerful government and corporate institutions to quickly legitimize crypto in much the same way as stocks and bonds. But does that make cryptocurrency a smart investment for you?

“Cryptocurrency is one of those categories of investing that doesn’t have those traditional investor protections,” said Gerri Walsh, senior vice president of Investor Education at the Financial Industry Regulatory Authority. “They’re outside the realm of securities trading. It’s an area that’s in flux, as far as regulations go.”

Professionals caution that investors shouldn’t put more than they can lose into crypto, which offers few safeguards, plenty of pitfalls and a spotty track record. If you’re thinking about adding crypto to your portfolio, here are five key considerations before you begin.

How do I start investing in cryptocurrency?

The simplest way to get your feet wet with crypto investments is to use US dollars to buy a cryptocurrency using a popular exchange like Coinbase, Binance or FTX. A handful of well-known payment apps — including Venmo, PayPal and Cash App — will let you buy and sell cryptocurrency, though they generally have limited functionality and higher fees. Whether you’re using Coinbase, Binance, Venmo or PayPal, you’ll be required to provide some sensitive personal and financial information — including an official form of identification. (So much for bitcoin’s reputation for anonymous transactions.)

Once your account is set up, it’s dead simple to transfer money into it from your bank. And the barrier to entry is quite low: The minimum trade amount is £2 on Coinbase and £15 on Binance.

What percentage of my portfolio should be in crypto?

Crypto is so new, there isn’t enough data yet to decide how much of your portfolio “should” be in cryptocurrency, according to Cesare Fracassi, who runs the Blockchain Initiative at the University of Texas, Austin. “We need decades of returns in order to understand whether a specific asset is good in a portfolio,” Fracassi said. “We know that on average stocks return about 6% more than bonds.

That’s because we’ve had 60 to 100 years to see the average returns on stocks and bonds.” Like all investment decisions, how much you pour into crypto will depend on your risk tolerance. But investment professionals suggest that investors keep their exposure low — even for those who are all-in on the technology.

Anjali Jariwala, a certified financial planner and founder of Fit Advisors, recommends that clients allocate no more than 3% of their portfolio into crypto.

What are the risks of investing in crypto?

Before investing in crypto, you should know there’s almost no protection for crypto investors. And since this virtual currency is extremely volatile and driven by hype, that’s a problem. It’s easy to get caught up in tweets, TikToks and YouTube videos touting the latest coin — but the adrenaline rush of a market spike can easily be washed away with a dramatic crash.

You should be on the lookout for crypto scams. One often-used scheme is a pump and dump, in which scammers encourage people to buy a certain token, causing its value to rise. When it does, the scammers sell out, often pushing the price down for everyone else.

These scams are prominent, and they took in more than £2.8 billion worth of crypto in 2021. From the US government’s current policy perspective, you’re on your own. At this time, the government provides no deposit protection for crypto as it does for bank accounts.

This may change following Biden’s March executive order, which directed government agencies to investigate the risks and potential benefits of digital assets. Best we can tell, only one company offers crypto insurance: Breach Insurance, whose Crypto Shield promises to cover your accounts from hacks. Other companies, such as Coincover, provides theft protection, which alerts you if there’s suspicious activity on your account.

Coincover maintains an insurance-backed guarantee that if its technology fails, it will pay you back up to the amount you’re eligible for, which depends on the level of protection the wallet you use offers. (Neither Coincover nor Breach Insurance insures you against scams.) Despite all the hype, scams and risks inherent in this market, Fracassi still thinks crypto has a viable future ahead of it. “I think crypto holds a possible solution to some of the problems of the traditional financial sector,” Fracassi said. “The current, traditional financial system is non-inclusive, it’s slow and expensive and incumbents, including large banks and financial institutions, basically have a lot of control.

I think crypto is a venue through which you can actually break the system.”

If I make money on crypto trades, do I have to pay taxes?

Yes. Whether you’re buying, selling or exchanging crypto, the IRS wants to know about it. Your tax liability depends on your particular situation, but crypto investments are broadly treated like other investments, including stocks and bonds.

You don’t need to report crypto on your tax return if you didn’t sell or exchange it for another type of crypto. Buying and holding also doesn’t need to be reported. If you did sell or exchange crypto, though, you’ll need to report any gains or losses realized, just like you would for stocks and bonds.

Adding crypto trades won’t make your tax return any easier.

But popular tax software like TurboTax, CoinTracker and Koinly now connect with wallets and exchanges to automatically track your cryptocurrency holdings, sales and transfers.

Is there a way to learn about crypto without investing in the currencies themselves?

Buying tokens is the most straightforward approach to crypto. But other opportunities exist for exploring the crypto world while potentially protecting your money from seesawing swings. Here are a handful of alternatives:

Buy shares of crypto companies. Many companies in the crypto space are publicly traded. Buying shares of Coinbase Global or PayPal Holdings rather than of the coin itself allows you to benefit from the business proceeds of these companies, which are in part generated by crypto. You can also buy shares of companies that make crypto-related hardware, such as Nvidia and AMD.

Invest in crypto ETFs or derivatives. Specialized exchange-traded funds, or ETFs, are available for crypto. ETFs are baskets of securities, such as stocks, commodities and bonds, that follow an index or sector, in this case, crypto. Futures and options are also available for some crypto products, though these advanced types of investment vehicles come with their risks.

Get a job in crypto. LinkedIn, Indeed and Monster list thousands of jobs in crypto. Whether you’ve got a traditional finance background or you’re a software engineer, there’s a boom in the blockchain labor market. There’s also Cryptocurrency Jobs, a job board dedicated to blockchain careers.

Whether you’ll plunge into crypto waters is ultimately up to you, but bear in mind it isn’t the only place to start your investing journey. And beyond crypto, there are other digital assets to consider, too, including NFTs. But if you do take the plunge, be sure to invest in a good wallet to keep your digital currency safe.

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