Cryptocurrencies have transitioned from a fringe curiosity to a mainstream financial asset over the past decade. While originally designed to democratize financial transactions, Bitcoin and other altcoins have become a valuable alternative asset class for investors. And soon, it could become an integral part of any portfolio.
This article discusses how crypto evolved into a financial asset, including the challenges and what’s next.
The Rise of Crypto
The first cryptocurrency – Bitcoin – was introduced in 2009 as an ambitious experiment aimed at eliminating intermediaries in e-commerce transactions and enabling micropayments. By decentralizing peer-to-peer payments, the technology was a bold and significant divergence from traditional financial models involving intermediaries.
While the original premise never caught steam, Bitcoin attracted a loyal base of crypto enthusiasts gathering for various reasons. Libertarians had a private way to transact without the potential for inflation; residents in countries with high inflation had a better way to transact; and technologists had a basis for a whole new digital-native ecosystem.
In June 2011, Bitcoin prices experienced their first massive price swing, rising from under $0.10 to over $30.00 in just a few weeks. In 2013, an even larger price swing brought prices from about $10.00 to more than $190.00. This volatility caught speculators’ attention, who began participating in the unregulated market.
In 2015, Ethereum arrived on the scene. Unlike Bitcoin, Ethereum served as a platform for permanent and immutable decentralized applications, transforming the crypto space into a new digital-native ecosystem. The second largest cryptocurrency also set the stage for non-fungible tokens (NFTs) and an explosion of altcoins.
The rise of Ethereum-powered NFTs and altcoins led to even more speculation (and fraud). Initial coin offerings (ICOs) became a new-age penny stock, enabling anyone to raise capital by issuing new crypto tokens. Meanwhile, NFTs created digital collectibles that quickly fetched hundreds of thousands of dollars apiece.
Investors Take Notice
Venture capitalists became early investors in the crypto industry. Sequoia Capital and other well-known VCs began pouring money into cryptocurrency projects that promise to change the world by revolutionizing everything from international money transfers to handling identity verification for banks and other institutions.
As volatility and volume rose, institutional investors entered the market to provide liquidity and generate profit from arbitrage opportunities. And traditional investors increasingly sought to get a piece of the action. As a result, many investment banks began trading in these markets and exploring the launch of retail investment funds.
In October 2017, Bitcoin took a major step toward legitimacy when the CME Group, the world’s largest derivatives marketplace, launched Bitcoin futures contracts. Institutional investors could speculate with futures contracts rather than buying and selling actual cryptocurrency like they already did with commodities and other assets.
The launch of futures contracts also set the stage for exchange-traded funds (ETFs). While spot cryptocurrency ETFs remain elusive, the SEC approved many futures-based cryptocurrency ETFs since they use pre-approved securities (futures contracts) trading on a regulated futures exchange. And many public companies began mining cryptocurrencies.
Regulators Catch Up
Regulators began taking notice of the crypto industry in 2013 when the SEC charged the first company with defrauding investors with a Bitcoin Ponzi scheme. When Ethereum’s launch opened the door to ICOs, the SEC began charging companies with unregistered securities offerings, setting the stage for future enforcement actions.
Meanwhile, the IRS began targeting traders and investors in new crypto assets. Citing a growing “tax gap,” the agency began subpoenaing crypto exchanges and sending warning letters to taxpayers it believed underreported crypto capital gains on their tax returns. And it continues to invest in crypto-related enforcement.
Without crypto-specific regulations, regulators have struggled to apply existing securities laws to new-age products. For example, the SEC believes most crypto tokens are securities subject to registration requirements, but the Howey test is unclear. And the IRS’s guidelines don’t address edge cases like wrapped tokens or DeFi products.
A series of high-profile crypto scams drew even more attention to the space. While a series of hacks led to significant investor losses, the collapse of FTX and its knock-on effects led to a massive enforcement push. By mid-2023, the SEC charged the largest exchanges, Binance and Coinbase, with running unregistered exchanges.
These efforts are catching the attention of higher-level regulators concerned about the knock-on effects on traditional financial assets. For example, stablecoins provide bank-like services to the crypto space without the associated reserve requirements. As a result, some regulators believe they pose a systemic risk to the financial system.
The Bottom Line
Over the past decade, cryptocurrency evolved from a fringe research project to a multi-trillion-dollar asset class. Bitcoin, Ethereum, and other cryptocurrencies are a staple in modern financial portfolios, helping provide diversification and exposure to an increasingly vibrant digital-native Web3 ecosystem.
However, the SEC’s lawsuits against Binance, Coinbase, and other high-profile crypto companies could usher in a new era of regulation. At the same time, BlackRock and Fidelity’s recent move to launch a spot Bitcoin ETF underscores the institutional interest in bringing digital assets to the masses – legitimizing the entire industry.
If you trade crypto assets, ZenLedger can help you organize everything for tax time. The platform automatically aggregates transactions across exchanges and wallets, computes your capital gain or loss, and generates the tax forms you must file yearly. You can also find ways to reduce your tax burden through tax loss harvesting.
This material has been prepared for informational purposes only and should not be interpreted as professional advice. Please seek independent legal, financial, tax, or other advice specific to your particular situation.