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Alternative Investments: Cryptocurrency Investing

Alternative Investments: Cryptocurrency Investing

Cryptocurrency investing is an alternative investment category worth considering for a diversified portfolio.

The first cryptocurrency was Bitcoin, invented in 2008. The ones that followed are often called “alt” coins, which is short for alternative coins.

The underlying technology is a peer-to-peer shared ledger that forms an immutable blockchain of encrypted data. Once an official block of transactions adds to the ledger, it is permanent.

Anyone on the network can see the entire blockchain record of all Bitcoin transactions from the first one until today. There is no centralized control of the ledger — millions of networked users have access to an identical copy of it.

Bitcoin, with its open-source software code, spawned thousands of cryptocurrencies. There are more than 15,000 alt-coins now, with new ones added daily. A few hundred or so have extraordinary value. Most do not, at least for now.

Some cryptocurrencies want to have utility (usefulness for transactions). Some aim to become a store of value with a pre-set and known total coin limit like Bitcoin. Others are “meme” coins started as a joke that have value due solely to their popularity.

Here are some insights about investing directly in crypto and ways to have investment exposure in this emerging sector without owning any cryptocurrency.

The Many Ways to Approach Cryptocurrency Investing

There are a variety of ways that you can participate in cryptocurrency investing. There are different ways that you can hold your cryptocurrencies. You can store your cryptocurrency on an exchange or in a private digital wallet.

Here is a brief overview of how to buy/sell cryptocurrency, the differences in storage methods, and the risks involved.

Buy and Sell Crypto Held for You on a Centralized Exchange

Coinbase.com is one of the largest cryptocurrency exchanges and the only one that is a public U.S. company. You can open an account and fund it by using a debit card. This strategy will allow you to be cryptocurrency investing in a few minutes.

Many investors appreciate how easy it is to use Coinbase, but it has some inherent risks, in that you do not hold your crypto yourself; the exchange safeguards it for you. This risk exposes your account to hacking problems and the possibility of a sudden loss in value if the exchange goes bankrupt.

The Coinbase commission fee for trade execution is higher than other exchanges, which very active crypto traders prefer. Nevertheless, if you want to have a modest position in cryptocurrency, holding some for trading on Coinbase may be appropriate for your needs.

Buy and Sell Crypto Held in Your Private Digital Wallet

An added layer of security for your protection is when you hold your cryptocurrency in a private digital wallet. There are many types of digital wallets.

For example, supported crypto obtained on the Coinbase exchange may be stored in a private Coinbase Wallet, which gives you full control and takes the crypto off the Coinbase exchange.

You can use the crypto held in your digital wallet for a transaction by permitting it to leave your digital wallet to go to Coinbase centralized exchange, or you might use it for a trade on a decentralized exchange (DEX) such as 1inch or Uniswap.

You are supposed to be the only person with access to your digital wallet by using its long password phrase, also called a "private key." You must guard this private key very carefully.

There is more safety in keeping your cryptocurrency in your private wallet. However, if you lose or forget your private key, there is no way to recover it. Anyone may use a stolen private key to access your digital wallet's contents.

Buy and Sell Crypto Through an Online Stock Brokerage Account

Online stock trading platforms such as Robinhood, Webull, and others allow certain crypto to be bought and sold through their platform. Check with your online stock broker because many are adding cryptocurrencies to their systems for trading.

Gain Investment Exposure in Cryptocurrency Without Buying Any Coins

There are interesting ways to gain investment exposure to cryptocurrency, which do not require buying any cryptocurrency directly. You might invest in buying shares in a Coin Trust, where the trust holds the actual cryptocurrency investments. Traders can speculate on cryptocurrency futures in the commodities markets. You may consider buying shares of an exchange-traded fund (EFTs) with cryptocurrency investments.

Here are some examples of this investment strategy:

Over-the-Counter Cryptocurrency Coin Trust

An online investment brokerage may allow trading shares in over-the-counter (OTC) cryptocurrency trusts. These trusts hold large amounts of cryptocurrencies.

These investments are extremely risky and usually only offered to accredited investors as private placements. They typically have very high fees and might be subject to extreme volatility and systemic risks.

Bitcoin Futures

Futures are a contract to buy a certain commodity at some future date for a certain price. Trading Bitcoin futures is the same as other commodities; you trade the contract and do not necessarily have to take actual delivery of the commodity. Bitcoin futures contracts settle in cash, not cryptocurrency.

Exchange-Traded Funds and Mutual Funds

Exchange-traded funds (ETFs) and mutual funds may hold investments in companies that have something to do with cryptocurrency, blockchain technology, or the emerging fintech sector in digital currency.

Cryptocurrency EFTs may hold shares in Bitcoin mining companies. EFTs may own shares in Tesla (TSLA,) which has about $1 billion of Bitcoin on its balance sheet.

  • BITO is an EFT that holds Bitcoin futures. Mutual funds exist that trade futures; some may also trade Bitcoin futures.
  • Blockchain EFTs focus on the underlying developments in blockchain technology rather than cryptocurrency. In terms of total assets, BLOK is the largest blockchain EFT.
  • Another example is BLCN, which has its largest holdings in Coinbase, Accenture, and Square.
  • Then, some EFTs focus on the computer power needed to handle all the cryptocurrency calculations, such as LEGR with its top investments in Fujitsu, Oracle, and NVIDIA.

Risk Considerations

Considerations is a nice word for "things to worry about." You should be very aware of the investment risk. Some financial professionals advise clients not to have more than 5% portfolio value exposure to highly volatile, risky assets like cryptocurrency.

Investing in cryptocurrency may feel like the wild west and the gold rush days; however, massive losses have also occurred. Exchanges faced massive thefts from hacking, fraud took some systems down, and investor sentiment continues to cause major volatility in price movements.

Regulatory Risk

The big unknowns are how regulations will change crypto markets. New laws may impact valuations and certainly will affect taxes.

One benefit of investing in cryptocurrency using a self-directed IRA is the deferral of taxes. Hopefully, you should have time to determine the tax implications before withdrawing money from your IRA. Using a private digital wallet on a DEX may not work for IRA investments.

If you can handle the risk, you must conduct extensive due diligence on any cryptocurrency investment or something related to it.

If you are managing a self-directed IRA, you will be the one making the investment decisions in ways that might produce a loss or an extraordinary benefit.

Read the Cryptocurrency FAQs for more information regarding investing and cryptocurrency transactions.

Going Forward

Are you excited to think about investing in cryptocurrencies or worried about their future? Like most, you probably have a mixed bag of feelings with a little bit of excitement and some trepidation.

This sentiment is a prudent way to approach learning about any new alternative investment category.

The good news is through self-directed retirement account management, you will have the option to make investments in cryptocurrency and related things if you choose to do so. Such a strategy may have tax advantages, so you might want to consult with a qualified financial professional or tax expert for more guidance on how to approach cryptocurrencies before investing.

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