To Bitcoin or not to Bitcoin, that is the question. Unless you’ve been trapped in the Sunken Place, you’ve likely heard something about Bitcoin or another form of cryptocurrency. Still, there’s a big difference between hearing about something and understanding it. And Bitcoin, despite its rising popularity, can be difficult to understand.
Especially when considering it as a potential investment for your retirement portfolio. Retirement can already be an intimidating subject. When you throw something called cryptocurrency into the mix, it’s easy to understand why people have questions.
Below we’ll break down what Bitcoin is, how it works, the advantages and disadvantages it offers as an investment, and whether or not you should buy bitcoin as part of your retirement portfolio.
What is Bitcoin and How Does It Work?
Bitcoin is a form of digital currency that exists on a blockchain. A blockchain is a public ledger on the Internet. These public ledgers use cryptography to secure their transactions, hence the name cryptocurrency. It’s also important to know there is no one central authority that updates this ledger.
Rather, computers run the respective bitcoin software in a peer-to-peer network. As a result, the currency is managed by a consensus reached by the computers in the network. The process of finding this consensus on the shared public ledger is known as “mining”.
Every ten minutes, computers in the network attempt to find an answer to a math problem the bitcoin protocol provides. The “winning” computer updates the ledger for ten minutes. Then it gets to keep the new bitcoins released within that time – equivalent to 12.5 bitcoins.
The first cryptocurrency created was Bitcoin. But since its conception, hundreds of other cryptocurrencies have been created. Now over 150,000 merchants worldwide accept bitcoin as payment for goods and services. In total, the cryptocurrency industry has grown to around $38 billion in market capitalization.
Advantages of Bitcoin as an Investment
Bitcoin, and cryptocurrency, in general, is like any other investment in that there’s always an implicit risk when investing. Still, the level of risk is an attribute worth examining in more detail. These are potential advantages of investing in a cryptocurrency.
1. Growing Industry
When Bitcoin first debuted one of the biggest factors against the currency was its lack of portability. As previously mentioned, there are now over 150,000 merchants, worldwide, who accept Bitcoin as a form of payment. Similarly, new payment exchanges make it possible for Bitcoin owners to shop online from sites such as Amazon.
2. Limited Supply
Another advantage of Bitcoin is the fact there is a finite supply. There will never be more than 21 million in circulation, at any one time. In fact, the amount being circulated will continually shrink. The new supply of Bitcoin halves every four years. This steadily decreasing supply means the network will mine the last coin in 2140.
3. No Custodian Necessary
One important advantage of cryptocurrency as an investment is the fact you don’t need an independent custodian to hold your investment. Investing without a custodian gives individuals full control over your holdings. It also protects investors from third-party mismanagement and fraud.
4. Increased Security
This advantage is tied closely to the previous one. Multisignature wallets are custodial tools that allow Bitcoin investors to maintain complete jurisdiction over their investment. These wallets can have two or three separate, private, keys. All keys are needed before a transaction is authorized. This gives your investment an additional level of security.
5. Independent from Other Markets
Bitcoin and other cryptocurrencies exist separately from traditional assets like stocks and bonds. When there is an economic crisis, bitcoins don’t necessarily fall in value with the rest of your assets. In fact, historically, bitcoin has increased in value in an inverse relationship with these typical investments.
6. Potential ROI
Cryptocurrencies have shown an ability to produce huge returns in short amounts of time. Even compared with higher volatility stocks. For example, $1,000 invested in Bitcoin in 2013, would be worth more than $400,000 today.
7. Enhanced Liquidity
Reaping profits from purchased startup equity requires one of three actions. Either another party buys the equity from you, the startup is acquired by another company, or an IPO is issued. But none of these options allow you to control when you cash out your investment.
Cryptocurrency ICOs (initial coin offerings), on the other hand, give investors increased liquidity. Once a cryptocurrency ICO is able to build a large enough network, investors can almost immediately sell off their cryptocurrency.
Disadvantages of Bitcoin as an Investment
Depending on who you ask Bitcoin is a more or less risky investment than other traditional ones such as stocks or bonds. These are some of the potential cons of investing in a cryptocurrency.
Bitcoin, in the U.S., isn’t specifically prohibited as an investment in an IRA. But that doesn’t mean cryptocurrencies will stay kosher for investors. For example, if the bitcoin market implodes and takes investors’ holdings with it, the market could see increased regulation.
Every investment carries at least a small portion of risk. Cryptocurrencies, though, are much more volatile than bonds, stocks, or even real estate. Major drops in ICO values are just as real of a possibility as the major jumps ICOs have recently experienced.
3. No Guaranteed Growth
According to Entrepreneur, the real value of a cryptocurrency is dependent on creating a strong product and an equally strong network of users will want to use. So, if the network can’t attract users, or never gets them to utilize the platform the currency will likely experience a significant drop-off in value. Many unsuccessful ICOs owe their post-launch failure to a lack of network engagement.
Like any Internet-based technology, there’s always a chance of a cybersecurity failure. Hackers could theoretically drain bitcoin investors of their entire cryptocurrency assets, in an instant. It’s worth noting bitcoin’s utilization of blockchain technology actually decreases the likelihood of a cyber attack. Still, the possibility of a hacking attack invariably exists.
5. Business Failings
ICOs are like any other startup in that there are many business-related reasons an investment could provide nothing. An ICO that fails to raise enough money, or spends more than expected, could have to shutter their doors before the product has a chance to take off.
Similarly, behind every ICO, like every new business, there is a team of founders. These people are responsible for establishing and building the cryptocurrency from the ground up. As with a startup, make sure you investigate the founding team’s background and determine if they have the right team to execute the undertaking.
Bitcoin in a Retirement Account
The IRS, in March 2014, stated it would treat bitcoin as a commodity for taxation purposes, the way it treats stocks or bonds. Yet, there are still questions limiting the widespread adoption of cryptocurrencies into mutual funds and other common investment vehicles.
A January letter from SEC questioned the risks of manipulation, whether funds could accurately value these products, and how they’d meet demands to redeem virtual currency. An SEC spokesperson said, “there are a number of significant investor protection issues that need to be examined before sponsors begin offering these funds to retail investors.”
You can still add Bitcoin to a self-directed IRA because it’s treated as a commodity by the IRS. In fact, there are already a few cryptocurrency-based IRAs popping up. One of the largest, CoinIRA, has converted more than $15 million into cryptocurrency holdings.
One of the biggest differences between CoinIRA and a normal retirement account is the fees. CoinIRA charges between 10 and 15 percent in a one-time fee. On the flip side, for example, an IRA at Fidelity doesn’t cost anything but charges $4.95 for a U.S. stock trade.
Nobody can tell you whether or not you should include cryptocurrencies in your retirement portfolio. Though the advantages and disadvantages of Bitcoin make it a unique investment. Still, like any other investment it’s critical you do your research and consult with your retirement advisor if you have one. There’s no need to be cryptic about the potential of cryptocurrencies.