What do you need to know about investing in Bitcoin, Ethereum, and other cryptocurrency? In some instances it’s the same thing you need to know about any investment–how much to invest, when to cut your losses, what makes a risky investment dangerous compared to more conservative approaches, etc.
Cryptocurrency investing requires you to remember and respect three basic very important things:
- Virtual currency is not a stable investment platform compared to mutual funds, bonds, Treasuries, etc. It can suddenly gain or lose value dramatically in a very short period of time.
- Virtual currency depends on the user storing and safeguarding cryptokeys for each Bitcoin or other currency. If you lose the keys, you lose the money. We’ll repeat that again below for emphasis. It’s how many newcomers get burned.
- Virtual currency is not regulated in the United States as currency. It is treated as property instead. Tax consequences may apply and you must report all required income or earnings from the sale, trade, or use of virtual currency as per IRS laws. These laws are subject to change and change often.
The rules for reporting Bitcoin earnings as appropriate are found on the IRS official site. There are some more complicated rules for virtual currency as used as what is known as a “capital asset.”
You should consult a tax professional to determine whether your involvement in cryptocurrency sales, trades, or other transactions results in your having a capital asset or not. Remember, tax code changes are common. Today’s tax law is not set in stone.
There are less obvious things about investing in cryptocurrency–some of which has specifically to do with the nature of the investment you’re making. Here are some very important dos and don’ts to follow–disregard at your own risk.
Bitcoin DO: Treat virtual currency like any other investment. That means being smart about your money, not putting all your cash into one type of investment, and maintaining a diverse portfolio. If all your money is invested in virtual currency, you are already taking an unacceptable risk of loss.
Bitcoin DON’T: Don’t invest in virtual currency without a stop-loss plan. This means setting up parameters when you will stop investing, try to sell your investment, or buy-and-hold depending on the risk tolerance you have.
If you invest in Bitcoin without a strategy for getting out of the investment should it begin to falter, you WILL LOSE your money at some point.
Bitcoin DO: Understand the nature of your investment. By this, we mean understanding how Bitcoin gains value (investor enthusiasm) and what Bitcoin is NOT (an investment backed by fiat currency, which is real-world money).
If you do not understand this, you WILL LOSE your investment at some point. Knowing how virtual currency works is key to making smart choices about investing in it.
You will need to learn some things about the technology behind virtual currency like Bitcoin and Ethereum. Not understanding the technical aspect of this type of investing puts you at a serious disadvantage. Your risk of loss is elevated significantly if you do not understand how this type of investing works.
If you have never heard of a margin call and don’t know what the consequences of leaving your money in an account subject to such, you likely aren’t ready for investing in virtual currency…yet. Do your homework and learn some investing basics BEFORE you commit your hard-earned cash. You’ll be very glad you did.
Bitcoin DON’T: Do not invest money in Bitcoin or Ethereum without first researching how to purchase, trade, and spend virtual currency.
Why do we say this? Because much like traditional investing, you don’t just log onto a website and start putting your money into investments.
You need an account, you may be required to provide identity verification for traditional investing (not necessarily true with virtual currency), you need to understand the applicable exchange rates, but where virtual currency is concerned you ALSO need a place to STORE your virtual currency.
These are known as digital wallets and you will need to understand how they work and why before you spend any money on Bitcoin. You should also know that Bitcoin wallets can be lost, stolen, compromised, etc. If you lose the data in your virtual wallet, you lose your investment. Why?
Because Bitcoin relies on something called keys–these are codes that identify your virtual currency.
These keys are basically the things you need to use your Bitcoins and without those keys, you CANNOT access, spend, trade, or sell them. You can store these keys in a digital wallet which may be stored on a portable drive, or online.
But you can also store them on paper and manually plug the keys in. Lose the keys, lose the money. It’s that simple.
Bitcoin DON’T: Do not rely on any single storage solution for your virtual currency keys. See the above warning about what happens if you lose your keys.
There is, at press time, no realistic way to recover unbacked-up lost or stolen keys without physically getting the hard drive, paper, or some other recorded evidence of the numbers.
This includes most forensic hard drive extraction techniques–it is extremely unlikely that you can recover lost keys using hard drive recovery methods. If you do not have the numbers assigned to your keys and cannot retrieve them in some way, you lose your investment. Make backups. Often.
Bitcoin DO: Pay close attention to the tastemakers and trendsetters involved in virtual currency including Bitcoin, Ethereum, etc. Why? Because virtual currency is volatile and subject to influences other types of more stable investments are resistant to.
When a single social media post on Twitter can dramatically change the value of Bitcoin, that’s a force you should respect in terms of your ability to make money rather than lose it.
Bitcoin DON’T: It is a very bad idea to leave your assets or money in a digital currency exchange. Use the exchanges to make the transaction but DO NOT treat the exchange like your digital wallet.
Why? Exchanges are extremely prone to hacking attempts by nature. There are also plenty of Bitcoin and virtual currency scams out there.
It pays to thoroughly research the exchange you are considering for your virtual currency transactions. Use trusted, reputable exchanges with good ratings and RESEARCH THE EXCHANGE ON GOOGLE to see what other investors are saying.
Don’t take the word of a handful of strangers. Read what A LOT of strangers write about the exchange you’re considering.
Bitcoin DON’T: As mentioned earlier, virtual currency is treated as property, not cash, for income tax purposes.
If you earn money trading, selling, or using Bitcoin, you will be required to report the appropriate earnings on your taxes according to federal law. DO NOT be ignorant of the tax consequences, failure to report income as required can result in the IRS revisiting your tax return later if it is not detected right away.
Bitcoin DO: Do explore your options for more stable versions of virtual currency known as “stablecoins.” These are virtual currencies that have actual cash backing them and securing their value.
Not all virtual currencies are designed the same, however and you may or may not find the longevity of any given brand new “altcoin” or stablecoin to be questionable without establishment of a track record showing the currency can compete in the marketplace.
Many alternatives show up, make a splash, and then fade away in a comparatively short amount of time.
Bitcoin DON’T: Do not assume that past performance on ANY investment is a predictor of future results. This is not something you can rely on–it’s Investment 101 advice, but many people make the mistake of assuming that if an investment has done well up to this point that it will definitely continue to do so.
The nature of any investing involves risk–don’t ignore these risks.
Bitcoin DO: Definitely DO avoid group efforts to alter the value of virtual currency. This activity is known by several nicknames including “pump and dump”.
These operations attempt to gather a group of investors together to artificially manipulate the price of a virtual currency before dumping it for a profit. These schemes are not only illegal, they are full of risk. As a member of such a group, unless you are a part of the inner circle of the plan you will likely get squeezed out by being informed just a bit too late that its is time to sell the currency.
Pump and dump schemes are unethical, illegal, and may be part of a larger scam to part you from your money.
Joe Wallace is a 13-year veteran of the United States Air Force and a former reporter for Air Force Television News