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Updated on Friday, January 4, 2019
You may have heard rumors of “Bitcoin billionaires” and seen mentions of cryptocurrency in the news. You also may have heard of the “Bitcoin bubble” and wondered whether cryptocurrency is poised to regain value after a series of 2018 drops. And you may wonder, as technology continues to evolve, whether cryptocurrency ever will have a place in your portfolio.
Below, learn what cryptocurrency is, whether cryptocurrencies like Bitcoin are safe and what to know before you invest.
What is Bitcoin?
Bitcoin is perhaps the most well-known type of cryptocurrency. Cryptocurrency is a type of electronic cash system, or virtual currency, that exists outside traditional banking institutions.
In 2009, the first Bitcoin software was released. Bitcoin was different from other early experiments in that it was anchored in blockchain technology. Unlike other currency systems, which rely on secure encryption held by an institution, blockchain is a decentralized digital database.
Since Bitcoin, hundreds of other cryptocurrencies relying on blockchain technology have become available, including Ethereum, Litecoin, Ripple and others. These often are bought and sold on a coin exchange, such as Coinbase or Bitfinex. In general, crypto cannot be bought or sold through “traditional” brokerages, but as cryptocurrency gains popularity, more brokerages, including TD Ameritrade, are establishing partnerships with crypto exchanges to enable crypto trading.
Once your crypto is purchased, it’s held in your virtual wallet. From there, you can allow your investment to grow or use it as a currency. Once you use it as currency, however, it becomes subject to taxes based on its value the day it was bought as well as the day it was used as currency.
How has Bitcoin performed recently?
Bitcoin reached a peak in December 2017 and has had a turbulent year since then. At the beginning of 2017, one Bitcoin was valued at a little more than $900. By mid-December 2017, Bitcoin was valued at nearly $20,000 per coin. After plummeting below $10,000 per coin in January 2018, Bitcoin has gone through a series of ups and downs but has never reached the peaks it did in 2017. As of January 2019, Bitcoin is trading at more than $3,500 per coin.
Other cryptocurrencies have had similarly volatile performances, with some analysts saying that crypto is still finding its feet in the investment world and positing that, despite performance, crypto likely is here to stay.
Is Bitcoin safe to invest in?
Some early investors in Bitcoin saw it as an obvious next step in an increasingly virtual world. Others were excited by the hype and the almost dizzying increase in value in such a short span. But no investment is entirely “safe,” and Bitcoin and similar technologies can be especially volatile.
Since Bitcoin is traded independently of many traditional exchanges, your money could be more vulnerable than it would be in a brokerage that is FDIC- or SIPC-insured. In addition, as the IRS focuses more on Bitcoin and other cryptocurrencies, it’s important for Bitcoin investors to be thorough in reporting any crypto losses or gains.
Bitcoin may be exciting, but the volatility that leads to big gains also can lead to big losses. That’s why it may be smart to look at an investment in Bitcoin as an investment with money you can afford to lose. While all investments carry risk, an investor who wants to make steady gains may be better served by a different investment strategy, such as investing their money in an index fund.
For example, the roughly $3,500 a Bitcoin is worth today could be invested in an investment fund. Assuming an annualized 9% rate of return, that $3,500 in a “traditional” portfolio, such as an S&P 500 index fund, could be worth over $8,000 in 10 years. While that $8,000 is not guaranteed, it’s impossible to even forecast a Bitcoin investment 10 years in the future, which is why it may be smart to treat Bitcoin and other currencies as risks with money you can afford to lose.
Bitcoin and other crypto may appeal to an investor who already has a diversified portfolio that helps achieve major financial goals, such as education and retirement, and has spare cash they can afford to lose. While the idea of turning a small investment into big bucks is tempting, remember that it’s only worth it if you can comfortably lose your initial investment.
3 alternatives to investing in Bitcoin
While Bitcoin and other cryptocurrencies are undoubtedly exciting, the lack of industry regulation and insurance can make Bitcoin a risky proposition for some investors. Less volatile ways to invest could include:
- Cryptocurrency futures. More and more traditional brokerages are offering the option to invest in cryptocurrency futures. Trading futures also can be inherently risky, but savvy investors familiar with the futures market may see crypto futures as a way to invest in crypto without putting their assets into an unregulated crypto wallet.
- A thematic portfolio. A thematic portfolio looks at investment trends and creates a portfolio based on those trends. For example, those interested in financial technology (fintech) may opt to create a portfolio of fintech stocks, which could help mitigate risk by diversifying your investments. Some brokerages offer thematic portfolio options; for example, Motif is a brokerage that specializes in professionally created thematic portfolios.
- Individual stocks using fintech and blockchain technology. Instead of investing directly in cryptocurrency, consider investing in companies that operate in the industry. Fintech and blockchain are two major trends that could be worth exploring on your own or discussing with a broker or independent financial advisor. Of course, buying individual stocks can be more risky than investing in an index fund, so these sorts of investments should be made with the realization that money may be lost.
How to handle the ‘next’ Bitcoin
It can be tough not to jump when you hear of a hot stock or trendy investment strategy. After all, no one wants to miss out on the next Apple or Netflix. But it’s wise to remember that for every big win, there are many big losses, and making the decision to keep the bulk of your investments in diversified portfolios can help minimize your exposure to risk and maximize the amount of money you gain through your investments.
At the end of the day, the age-old investing advice rings true for Bitcoin, crypto, and other buzzy investment opportunities: Most investors take action based on 1% of financial news they consume. Read widely, invest in your knowledge, and don’t jump based on headlines. Your investment portfolio doesn’t need exclamation points and sky-high graphs to be a solid option for your financial goals.