Risks Of Cryptocurrencies

Talk about investing in Bitcoin and the news of people becoming ‘bitcoinnaires’ are almost everywhere these days – newspapers, TV’s, radio, and the Internet. However, one thing is missing from these stories: the tax man.

The IRS(Internal Revenue Service) began issuing guidance on taxation of Bitcoin in March 2014. At that time, the agency announced that Bitcoin would be treated as property, with loss or gains being treated as capital loss or capital gains for tax purposes.

Readers are probably familiar with the many “rags-to-riches” stories about Bitcoin investors becoming millionaires almost overnight. Such stories abound, from the Idaho teenager who turned $1,000 into $1.1 mln and the Norwegian engineer who made $800,000 in profit off a $24 investment.

While it's clear digital currency has its advantages over government-issued legal tender, wise investors should be aware there are risks involved in the investment and use of cryptocurrency.

For example, digital currency is used just like traditional bill-and-coin currency for purchases and online payments, but it's also considered a commodity, just like silver or gold. That means it's just as vulnerable to market fluctuations as any other commodity or stock would be. We aren't pointing this out to warn people away from making cryptocurrency investments, but to make it clear the market can move up and down—and, as is the nature of a young and active commodity—it can sometimes do so quite wildly. It's best to take a longer “big picture” view of your investment, as opposed to letting a momentary drop in value send you into a panic.

Digital currency coins are encrypted to keep them secure—but there's a potential drawback there. This coding identifies the currency itself, but not its owner. Whoever holds the coin's encryption code becomes its owner, and there's nothing in the coin's coding that says it belongs specifically to you—or to anyone else. This built-in anonymity feature means when a coin is stolen, it's gone—and you have little to no recourse in getting it back.

Just as you should be aware of the market risks we listed above, you should also know other risks can affect digital currency—just as they can any financial tool. Again, it's not a reason to give up and walk away—but you should go into the situation with your eyes wide open because no one knows when the bubble burst.