Key Takeaways
- Consider whether crypto fits their portfolio goals, risk profile, and personal convictions before investing.
- Crypto is highly volatile, and does not have the same regulatory protections as registered securities. It's also not insured by the FDIC or protected by SIPC.
- As a digital asset, crypto also requires specific security and tax considerations.
Many of the assets we currently trade have long, storied histories. The use of gold in trade has been traced as far back as 560 BC to the ancient Kingdom of Lydia. The first modern stock exchange was created over 400 years ago in Amsterdam. Even ETFs have now been traded for over a quarter of a century.
In contrast, crypto has only been around for a little over a decade. The original decentralized cryptocurrency, bitcoin, was first mined in January 2009. While the technology is in many ways revolutionary, the industry is still very new, and the regulatory framework is still uncertain. The result is a market that currently experiences substantial volatility, triggered by various factors including crypto exchange bankruptcies and high-profile hacks.
Wondering if crypto is right for you? Begin by asking yourself these 5 fundamental questions:
- 1. Do you understand the crypto landscape?
- 2. Are you comfortable with the volatility?
- 3. Can you handle the investment risks?
- 4. Do you know how to store your crypto safely?
- 5. Do you understand the tax implications?
Let's take a closer look at what to consider for each of these questions.
1. Get educated
When you hear about people buying crypto, it might sound like a singular asset like a stock or a bond. It's not. "Crypto" encompasses a wide range of investments with varying purposes, including bitcoin, ethereum, and more than 19,000 other cryptocurrencies—many untested and unlikely to survive.
Before you jump in, get educated on the ins and outs of this fast-growing industry. For example, you should be able to explain the value of blockchain technology and decentralization to friends and family. If you're interested in bitcoin, you should know why concepts like cryptographic hashes and mining are important to its function.
In addition to the fundamentals, stay up to date on the latest crypto news. It's a fast-paced market, and new developments happen almost daily. Government regulations are also evolving, and each new decision can impact how crypto is treated legally.
Once you've learned how the technology and economics work, be honest with yourself: Do you truly believe crypto will have value in the long run? If your answer is "no" or "I'm unsure," it may not be right for you. This is an important question because choppy markets may test your conviction.
2. Prepare for risk and volatility
There are no two ways about it: Crypto is highly volatile, and may be more susceptible to market manipulation than securities. Crypto holders do not benefit from the same regulatory protections applicable to registered securities, and the future regulatory environment for crypto is currently uncertain.
Furthermore, it's also not insured by the Federal Deposit Insurance Corporation (FDIC) or protected by the Securities Investor Protection Corporation (SIPC), meaning you should only buy crypto with an amount you're willing to lose.
You'll want to ask yourself if you're comfortable with these risks before entering the market.
To better understand the volatility, let's look at some numbers. Consider bitcoin, the oldest and largest cryptocurrency by market cap. Bitcoin's price regularly experiences both double-digit drops and double-digit rallies, sometimes within the same week. If you bought a single bitcoin at $7,000 at the start of the coronavirus pandemic in March 2020, it would have risen to $69,000 in November 2021—a gain of over 850%. But by June 2022, it would have plummeted to $17,500—a price cut of over 70% from its November highs.
Ethereum has seen its share of volatility as well. In March 2020, it hovered around $120. It then skyrocketed over 3,900% to $4,867 by November 2021. By June 2022, it had dipped back down to $880.
Beyond these two crypto giants, the volatility can get even more hair-raising. Take the Terra network's token LUNA. Once a widely held cryptocurrency, LUNA saw its price tumble from a high of nearly $120 to functionally zero in May 2022 after its financial underpinnings collapsed. Dogecoin's price history consists of some even more stunning swings, including a gain of over 42,000% from March 2020 to November 2021. By June 2022, it had fallen over 90% from its all-time high.
Despite the 2022 bear market, those who entered the crypto market with a buy-and-hold mentality in 2020 or earlier may still have gains. But many investors have also lost money, or will realize losses down the road. Time will show if cryptocurrency prices become less volatile over time. For the near future, however, prepare for continued volatility.
3. Manage risks
Given the uncertainty of trading crypto, it's best to think defensively. While there can be a lot of upside, remember that the downsides can be sudden and sharp. Also note that crypto may have a higher chance of going to zero than many other assets. In light of this, limit your allocations to an amount you can afford to lose.
If you're looking to diversify your portfolio or are saving for a particular goal (particularly a short-term goal), crypto may not be an appropriate vehicle due to its unpredictability.
If you make gains that make crypto a larger part of your portfolio than intended, consider reallocating at least some of those gains to more stable asset classes. This may help iron out some of the unpredictability from your overall holdings.
4. Get smart about security
One of the most important aspects of buying crypto is storing it safely. Those who aren't interested in learning the ins and outs of crypto cybersecurity may find it easiest to keep their coins with a trusted custody provider with strong and audited security protocols. These platforms generally have security processes that may be better suited for beginners.
On the other hand, those looking for a more hands-on approach may choose to custody and secure the asset themselves. This typically involves buying crypto on a crypto trading platform, then transferring holdings to a private digital wallet or physical cold wallet (a USB-like device for crypto storage).
Note that while this route gives you more flexibility with how you use your crypto, there's also no customer service team for those who manage their own security. If your private or exchange accounts are hacked or phished, the crypto trading platform you use goes bankrupt, or you transfer your coins to the wrong wallet address, you may lose access to them forever.
5. Don't forget taxes
On the surface, crypto is currently taxed a lot like stocks. Holdings sold at a profit trigger the capital gains tax, while those sold at a loss may allow you to take deductions.
However, there are also more nuances to consider. For example, paying for goods and services with crypto may also trigger capitals gains or losses. There are also evolving tax rules regarding crypto received for mining or staking, or as part of an airdrop or hard fork.*
Because the industry is so new, tax rules can change rapidly. Consider reviewing the basics on crypto taxes before buying. And while many tax preparation software programs are building crypto calculations into their platforms, you may also want to consult with a tax professional to ensure your filings are accurate.
Summing it up
Crypto is currently an exciting but speculative asset with high volatility. It's not protected by the same regulations that apply to registered securities, and is not insured by the FDIC or protected by SIPC. To prepare yourself for the risks, make sure you have assessed its long-term potential before you buy. And once again, limit your allocation to an amount you can afford to lose.
Be sure to study all your security options before buying. Choosing between storing your coins with a trusted custody provider versus a crypto trading platform could make a big difference when it comes to protecting your assets, especially if you don't have the time to study crypto cybersecurity protocols.
And as with all financial holdings, make sure you understand the tax implications. The rules for crypto are different from that of traditional asset classes, so don't leave room for unwelcome surprises come tax season.
When all is said and done, keep risk management at the forefront of your crypto trading strategy. This may help you minimize stress in both the short and long term.
*Quick definitions: Think of mining as freelancing. You're paid in cryptocurrency for your work. Staking involves voluntarily locking up money in a special account. You receive interest on the amount you lock up, and the interest is what's taxed. Hard forks happen when a cryptocurrency splits into two versions. As a holder, you typically receive airdrops of the new version.
