Bitcoin has been a rollercoaster ride for investors over the past three years with prices rising as high as $20,000 before falling below $4,000. The good news is that the market has matured and prices have begun to stabilize. New futures markets have reduced volatility and upcoming crypto exchange-traded funds could open the door for mainstream investors.
Let's take a look at three reasons that investors may want to consider adding cryptocurrency to their portfolios.
Cryptocurrencies have been a rollercoaster ride over the past three years, but the market is maturing and many investors are taking a second look.
#1. Long-term Potential
Enthusiasts have long touted the potential for cryptocurrencies to replace fiat currencies, but they still haven't achieved traction among everyday consumers. With the launch of stable coins, like Facebook's Libra, these dynamics could begin to shift as the public is introduced to the idea of digital currencies that operate on the blockchain.
There are many potential benefits of using cryptocurrencies over other forms of fiat currency or digital payments:
- Decentralization - There's no central authority that's capable of suddenly increasing or decreasing supply, which means that the currency could be a better store of long-term value.
- Pseudo-Anonymity - Anyone can make large transactions without people easily knowing their identity, which is very difficult when dealing with fiat currencies.
- Public Ledger - Many cryptocurrencies have a public ledger that provides transparency to the market, while making it possible for regulators to track transactions.
- Low Friction - There's theoretically less cost to transact cryptocurrencies compared to fiat currencies, while governments don't have to pay to mint new coins.
There's no doubt that it will take a lot of time for the public to embrace cryptocurrencies and something better could arise along the way. That said, investors willing to assume these risks to become early adopters — in the same way that investors pick emerging stocks — could invest a portion of their portfolio in cryptocurrencies.
Most investors know not to keep "all of their eggs in one basket". For instance, if you hold all of your capital in energy stocks, a downturn in oil prices could devastate your entire portfolio. A diversified portfolio spreads out the risk without adversely impacting returns over the long run, thereby increasing your long-term risk-adjusted returns.
Coinbase vs. S&P 500 Performance - Source: FRED
Cryptocurrencies have a relatively low correlation with conventional financial assets, such as the S&P 500 index (above), which makes them a potential candidate for asset-level diversification. Investors may hold, stocks, bonds, commodities, and cryptocurrency as part of a well-diversified portfolio of assets to maximize risk-adjusted returns.
Until recently, cryptocurrencies were too volatile for most investment portfolios with beta coefficients well-beyond an acceptable range for long-term portfolios. The recent improvements in volatility could make them an appropriate tool for diversification, however, particularly with the advent of crypto ETFs that make it easier to hold a diverse portfolio.
#3. Hedge Against Risk
Many investors consider cryptocurrencies to be a safe-haven asset class since they are not correlated with conventional financial assets. If you're concerned about a market downturn, you could sell stocks and purchase cryptocurrency to "cushion" a decline in the stock market in the same way that many investors already purchase precious metals, like gold.
Cryptocurrencies have a few potential benefits over precious metals as a hedge against risk:
- Storage Costs - Cryptocurrencies have no storage costs since they are held electronically, while most gold investments involve the stock of storing the physical metal.
- Transaction Costs - Cryptocurrencies have very low transaction costs since the coins are transacted online whereas gold must be transported from place to place.
Like gold, cryptocurrencies do not pay a yield, like bonds, or hold income producing assets, like stocks. Cryptocurrency prices have also historically been more volatile than gold prices, which means that it may be a little riskier of a safe-haven asset. It's important to consider these factors when using cryptocurrencies as a safe-haven asset class.
Important Tips & Caveats
Cryptocurrencies are treated like property by the IRS, similar to stocks or bonds. Unlike stocks or bonds, the process of calculating the cost basis can be much more complex. Investors must determine the fair value in U.S. dollars when selling an asset — even if it's converted into another cryptocurrency rather than U.S. dollars or fiat currency.
Fortunately, ZenLedger makes it easy to aggregate transactions across exchanges and automatically compute the cost basis. The platform then autocompletes popular IRS forms, including Form 1040 Schedule D and Form 8949, that you can provide to your accountant. You can even generate alternative forms that may be required, such as FBAR, on an as-needed basis.
One unique benefit of investing in cryptocurrencies, for now, is that tax loss harvesting isn't subject to the wash sale rule. You can sell a losing position to realize the loss and immediately repurchase the cryptocurrency to maintain your portfolio allocations without running afoul of IRS rules. ZenLedger helps you automatically identify these opportunities.
Try ZenLedger today to simplify your crypto accounting!In addition to tax considerations, investors should keep an eye on ongoing regulations surrounding the space — especially the SEC’s recent actions. The SEC has been active in policing initial coin offerings, or ICOs, for conducting unregistered securities offerings, while the agency has yet to approve a cryptocurrency ETF.
The Bottom Line
Cryptocurrencies are rapidly evolving from a hobby project to an important alternative investment class. Whether betting on long-term potential, diversifying, or fleeing risk, there are several ways that investors are using these assets in their existing portfolios. The key is ensuring that they are properly diversified and accounting for the tax implications.
ZenLedger makes it easy for investors to account for cryptocurrency transactions on their taxes, making it a critical tool for investors in the space. With the 2019 tax season starting on January 27, investors may want to consider the solution to get everything in order.