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1. Home
2. Market Commentary
3. Cryptocurrencies: Should You Invest in Them?
Market Commentary
November 17, 2021
CRYPTOCURRENCIES: SHOULD YOU INVEST IN THEM?
By Schwab Center for Financial Research
Bitcoin and other cryptocurrencies have been growing in popularity, but if
you’re considering investing in them, there are some key things you should know
first.
Beyond learning the basics of cryptocurrencies, investors should keep the myriad
risks in mind, including that the value of even the most popular
cryptocurrencies have been volatile, the market isn’t very transparent,
transactions are irreversible, consumer protections are minimal or nonexistent,
and regulators haven’t clarified their approach to regulating them. We suggest
that investors who want to invest in cryptocurrencies treat them as a
speculative asset using funds outside a traditional long-term portfolio.
Let’s take a closer look at some of the issues surrounding them:
WHAT IS THE SEC’S TAKE ON CRYPTOCURRENCIES?
The Securities and Exchange Commission generally has been skeptical of
cryptocurrencies, with chairs expressing concern that the product is too
volatile, that investor protections are inadequate, and that regulations are
insufficient. The agency has rejected multiple applications for exchange-traded
funds (ETFs) that invest directly in Bitcoin over the last several years.
In August 2021, SEC Chair Gary Gensler said that he was open to the idea of ETFs
that invested in cryptocurrency futures, but not those that invested in the spot
markets, because the futures markets are already regulated by the Commodity
Futures Trading Commission. In October 2021 the first two Bitcoin futures
ETFs—the ProShares Bitcoin Strategy ETF (BITO) and the Valkyrie Bitcoin Strategy
ETF (BTF)—were approved and launched. While it’s likely that more will soon
follow, initially they will be limited to Bitcoin and Ethereum, as those are the
only two cryptocurrencies for which an active futures market is currently
established.
WILL BITCOIN OR OTHER CRYPTOCURRENCIES BECOME THE NEW GLOBAL CURRENCY?
Until there is appropriate regulation and consumer protections, we don’t think
so, but time will tell. To be viable, a currency usually requires three
characteristics:
* It can be used as an inexpensive, reliable medium of exchange;
* It can be a unit of account;
* It can be a store of value and legal tender honored as a means of payment.
As long as Bitcoin is subject to high volatility and hefty transaction fees, it
seems likely that it will have only limited use as a medium of exchange, a unit
of account, or a store of value. Another barrier to broader public acceptance as
a true currency is that, as cryptocurrencies become more widespread, the risk of
regulation probably will rise—eliminating part of their appeal to those
investors who perceive them as a currency not controlled by central bank policy
or national governments.
CAN BITCOIN BE USED AS A HEDGE AGAINST INFLATION?
Because the value of Bitcoin is currently not tied to the value of a basket of
goods or services, its value as an inflation hedge is a matter of speculation
and is unpredictable. Throughout much of 2021, Bitcoin experienced both sharp
rallies and sharp price declines even though inflation data consistently ticked
higher. Whether Bitcoin will prove to be an effective inflation hedge in the
long run is yet to be determined.
HOW ARE CRYPTOCURRENCIES TAXED?
The IRS treats Bitcoin as property, not currency. Cryptocurrency transactions
are taxable by the IRS whenever a taxable event occurs, such as selling Bitcoin
for a fiat currency, paying for a product or service with Bitcoin or trading it
for another asset. Investors are responsible for tracking cost basis, gains, and
other reporting. For help, refer to IRS Notice 2014-21, or consult with a tax
advisor.
Officials at the Department of the Treasury recently said they would seek to
implement stricter reporting requirements on cryptocurrency transactions. The
proposal would require that exchanges of $10,000 or more of cryptocurrency be
reported to the IRS, similar to current reporting requirements for cash
transactions. No formal proposal has been submitted yet, so it’s not clear what
the timing of such a rule would be. However, it’s important to remember that
this $10,000 reporting requirement does not mean that a cryptocurrency
transaction of less than $10,000 is not taxable. The tax code states that “all
income from whatever source derived” is taxable, even if it’s not reportable to
the IRS. For example, an individual who sold $500 worth of items at a flea
market would still owe taxes on that income, even though it was not reported to
the IRS on a Form 1099.
ARE CRYPTOCURRENCY TRADES SUBJECT TO WASH-SALE RULES?
Tax experts believe that because the IRS currently considers cryptocurrencies to
be property, not securities, losses are treated differently from those of stocks
and mutual funds, so wash-sale rules generally don’t apply. However, the IRS and
the SEC generally have been quiet on this topic and guidance is subject to
change at any time.
WHAT ARE SOME RISKS OF BITCOIN AND CRYPTOCURRENCIES?
* Financial loss. Bitcoin and other cryptocurrency prices historically have
been highly volatile, and fluctuations could result in significant losses if
sold at the wrong time.
* Future regulation. Cryptocurrency issuance and trading is currently not well
regulated, and additional oversight and regulation in the future is likely.
U.S. Treasury Secretary Janet Yellen has noted her concern over
cryptocurrencies being used “for illicit financing.”
* Fraud and cybercrime. These already have occurred. Given concerns above,
cryptocurrencies could come under scrutiny from the Financial Crimes
Enforcement Network (FinCEN), for noncompliance with the Bank Secrecy Act
(BSA) and anti-money laundering requirements. Bitcoin exchanges have been
subject to computer outages caused by excessive demand, and because the
ledgers are held on the internet, a large-scale cyberattack could limit
access in an emergency—something less likely to happen with cash or gold.
* Theft or loss. A login ID and password is usually required to access a
cryptocurrency exchange. If this is lost, hacked, or stolen, access could be
denied or lost. While uncommon, bitcoins can be stored in physical wallets,
so they can be spent without a computer; this creates the same risks inherent
in all cash currencies: They could be lost, stolen, or destroyed by accident.
DOES SCHWAB RECOMMEND INVESTING IN CRYPTOCURRENCIES?
Bitcoin and other cryptocurrencies are speculative investments, in our view. We
don’t believe that Bitcoin fit within traditional asset allocation models at
this time, as it is neither a traditional commodity, such as gold, nor a
traditional currency. Bitcoin’s dramatic volatility is driven primarily by
supply and demand, not inherent value. Bitcoin doesn’t have earnings or
revenues. It doesn’t have a price-to-earnings ratio, price-to-sales ratio, or
book value. Traditional value metrics don’t apply, so there are no methods for
assessing its value that we endorse or find persuasive.
Whether you should invest in cryptocurrencies depends on your goals and
preferences as an investor, as it does with any asset or security. We suggest
that clients approach it as a speculative investment and consider the high
volatility and risks involved. For those who already have a diversified
portfolio and a long-term investment plan, we see ownership of cryptocurrencies
as outside the traditional portfolio.
1 Satoshi Nakamoto published the white paper “Bitcoin: A Peer-to-Peer Electronic
Cash System” on Oct. 31, 2008.
WHAT YOU CAN DO NEXT
* Explore more about this topic in “Cryptocurrencies: What Are They?” and
“Cryptocurrencies: How You Could Invest in Them.”
* Read about managing risk.
* Learn about ways to invest in cryptocurrency at Schwab.
* Schwab clients, please reach out if you’d like to discuss your
portfolio. Contact your Schwab Financial Consultant or call us
at 800-355-2162. If you’re not a client, learn how Schwab can help you reach
your goals.
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