Anyone who has invested in Bitcoin knows just how wild a ride the past few years have been. After experiencing an astonishing increase of ~1,240% in 2017, Bitcoin plummeted by around 75% the following year and became somewhat of an afterthought.

The digital currency made it back into the spotlight in 2020 with a 300% rally and caught the attention once again of many investors. Much of the recent spike can be attributed to two main factors:

Pandemic: With the outbreak of COVID-19, concerns regarding government debt levels, currency debasing, and inflation have many investors worried about the future of fiat currency, which has shifted the attention toward Bitcoin.
FOMO: There is a lot of Bitcoin hype now, which has many people investing with the hopes of making a quick or large return. It seems everyone knows someone who has “made money” in Bitcoin.

I don’t want to use this post to explain the history and workings of Bitcoin. You can read this for more information.

Should You Buy Bitcoin?

The big question for most investors is whether Bitcoin (or any cryptocurrency) should be part of a diversified portfolio.

We have been watching closely as “digital assets” evolve. We do think that they may end up being just another way to diversify holdings. Still, the current climate is full of risk and uncertainty—more so than traditional asset classes like equities, bonds, and real estate.

It is important to distinguish between investing in Bitcoin to make money versus its long-term ability to become a viable currency or asset class. Before you make an investment decision, several factors should be considered, which we cover below.

Storage

Unlike cash, which can be stored in your wallet or a bank, cryptocurrencies get stored in a digital “wallet,” which can be hardware or web-based and consist of a string of private numbers and letters.

Many marketplaces allow individuals to buy and sell Bitcoin using different currencies. Your digital wallet is typically stored either in the cloud or on your computer. But holding it has become easier with online payment companies like PayPal or apps like Coinbase offering to do the “storage” part for you.

Unfortunately, most things on the internet can be hacked. In fact, many crypto exchanges have been, to the tune of about $2 billion. Some of this hacking can be attributed to individuals failing to take the proper security precautions, but oftentimes, it is due to the security issues with the exchange.

While security is likely to improve over time, it remains a problem. There are proactive steps you can take, such as storing the information locally on your computer or establishing a cold wallet (offline wallet). But these also have their risks and require a higher level of technical knowledge.

It is important to note that hacking is not a Bitcoin problem. In fact, the blockchain technology that most cryptocurrencies are built on is likely a big part of the future for traditional banking and investing, and coincidentally should lead to a “safer” marketplace when it comes to cybersecurity.

Taxes

The IRS recently ruled that Bitcoin and other “convertible virtual currencies” are treated as property since you’re converting a currency (i.e., U.S. dollars) into Bitcoin.

Presently, virtual currencies do not have legal tender, which means each transaction has potential tax consequences. In addition, you face capital gains or losses every time you purchase goods or services using Bitcoin. This can become a record-keeping nightmare.

All transactions need to be filed on IRS Form 8949 (Sales and Other Dispositions of Capital Assets) and will be taxed as either short-term or long-term capital gains.

If Bitcoin is going to be used to buy and sell goods, the fact that every transaction needs to be recorded and carries a potential tax consequence is not an efficient or desired outcome.

While I believe this process will improve over time, it’s currently a headache.

Now, for someone who buys Bitcoin and plans to hold it long-term, they won’t face any tax consequences until a transaction is made.

We acknowledge that many people have been drawn to Bitcoin because it can be hard to trace. But managing it legally and through a provider such as PayPal or Coinbase means your transactions are recorded, so make sure to file those taxes properly.

Beneficiaries

With investment or bank accounts, you can easily assign beneficiaries as desired. With Bitcoin and other cryptocurrencies, it is trickier.

Ideally, you would leave these assets through a will or a trust. Doing so makes it less likely that your cryptocurrency will go undiscovered upon your passing, as there will be documentation of its existence, and helps to avoid probate.

It is important to remember that these documents are binding, and if your legacy wishes change, you will need to update your estate documents to reflect the change.

Many cryptocurrency exchanges and “providers,” however, are not set up to even have joint accounts, much less named beneficiaries.

Volatility

For Bitcoin to become a viable currency, three requirements need to be met:

Mass adoption
Increased security
Reduction in volatility

These requirements go hand in hand, as the best way to obtain mass adoption is by providing enhanced security, which will then reduce volatility and make individuals feel more comfortable holding it.

While eliminating the middleman has its benefits, it also presents a glaring issue, as there is no formal oversight or regulation protection. This makes mass adoption of Bitcoin difficult, especially if it continues to exhibit volatility more than four times that of equity markets.

With trading becoming easier and more accessible, it seems unlikely that volatility will subside anytime soon, which is a negative if the goal is for Bitcoin to become a reliable currency.

On the other hand, it is encouraging to see several banks and mutual fund companies showing an interest in investing in Bitcoin and blockchain technology. This illustrates that interest exists beyond the retail investor, which is a positive. Having a new asset class to invest in should help long-term investors.

Portfolio

Bitcoin should be viewed as an alternative asset within an alternative asset class (digital assets), which can add diversification to a portfolio.

Currently, most investors do not feel comfortable holding an investment this volatile. While volatility levels have decreased in recent years, they remain high compared with every other market.

During recent periods of market crisis, Bitcoin value has also significantly declined—but since inception, it has acted as a good diversifier to equity markets.

Unlike stocks and bonds, Bitcoin doesn’t generate cash flow or provide intrinsic value. Of course, neither does gold, yet it has been viewed as a safe haven of sorts for a long time.

In summary, should Bitcoin or cryptocurrencies be a part of your “workhorse” portfolio? We don’t think so. But if you can afford to lose a carved-out portion of your “racehorse” portfolio, then who are we to say don’t do it?

Currently, no major custodian (TD Ameritrade, Schwab, or Fidelity) offers direct Bitcoin investing, but trends are developing rather quickly with possible options in exchange-traded funds (ETFs) and exchange-traded products (ETPs).

Such options could help stabilize cryptocurrencies to a certain extent and offer a more regulated way to invest. We shall see.

Nothing about this post should be taken as a recommendation to buy or sell Bitcoin or any other cryptocurrency. An investment in Bitcoin and cryptocurrencies should be considered as extremely speculative.

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