When the value of an investment suddenly soars or collapses, it tends to get a lot of media coverage. In 2017, that investment was Bitcoin.
This highly publicized cryptocurrency started 2017 priced at $978 and, as of early December, reached a value of more than $17,000. That’s a return of more than 1,600 percent in less than a year. No wonder everybody is talking about it. But should you invest in it?
The first question to ask: What should Bitcoin be worth? It is not a productive asset, therefore its price, just as with gold, is based solely on supply and demand. If you don’t understand the drivers of those factors, and their impact on Bitcoin’s price, then you wouldn’t be investing, you’d be gambling.
Following are the four biggest myths I believe people continue to hold regarding this relatively new investment opportunity. I offer them so that you can consider a Bitcoin investment rationally rather than emotionally.
• Myth No. 1: Bitcoin is a currency. A currency is a medium of exchange created to make the buying and selling of products and services easier than having to barter for them. That obviously requires that the value of the currency be relatively stable. In the case of Bitcoin, notwithstanding 2017’s stellar gains, its price has fallen by more than 85 percent not once but three times over the past seven years. And it has experienced a drop of 20 percent or more every quarter since 2013. Never in history has any country’s currency fluctuated by so much in such a period of time.
If you were to purchase consumer goods using bitcoins, you’d go nuts. A TV selling for $1,000 in bitcoins on one day could cost you $1,500 the following week. As a medium of exchange, Bitcoin is totally impractical. That’s why more than 90 percent of all transactions using bitcoins are taking place on the dark web. Presumably the lack of traceability is more important than price stability for illegal trading.
• Myth No. 2: There are no tax consequences with buying and selling Bitcoin. The IRS considers cryptocurrencies such as Bitcoin to be intangible property subject to capital-gains rules. If you buy bitcoins with U.S. dollars and later sell them for U.S. dollars, you have to report and pay taxes on any capital gain or loss on that transaction. Even if you trade bitcoins or leveraged Bitcoin contracts on Bitcoin exchanges without converting the underlying bitcoins back into U.S. dollars, you will still be taxed on realized capital gains and losses on each trade.
• Myth No 3: An investment in Bitcoin is an investment in digital technology. There is an underlying technology supporting Bitcoin, called Blockchain. It eliminates the need for an intermediary (like a bank) to ensure transactions are properly recorded and bitcoins are not stolen. As a new technology, it has tantalizing possibilities in many different fields. But what does investing in Bitcoin have to do with investing in Blockchain? If you want to invest in the technology, why not invest more directly in the companies that perform so-called Bitcoin mining or those that are developing other cloud-based Blockchain applications?
• Myth No. 4: Investing in Bitcoin is safe. Many of the promoters of cryptocurrency investments are not following federal and state securities laws. As a result, you may not be able to recoup any lost investments made through unscrupulous exchanges or custodians. The U.S. Securities and Exchange Commission warned just this month that “the SEC and state securities regulators are pursuing violations, but we again caution you that, if you lose money, there is a substantial risk that our efforts will not result in a recovery of your investment.”
Still ready to buy? The emotional fear of missing out can be a powerful motivator. But did you know that there are more than 500 alternative cryptocurrencies available for investment, each with a market cap greater than $1 million? Not to mention gold itself?
If you are going to invest in a cryptocurrency, why choose Bitcoin? Will it ultimately win out or fall by the wayside? Caveat emptor!
Los Altos resident Artie Green is a principal at Cognizant Wealth Advisors, cognizantwealth.com.