Are cryptocurrencies the future?

Is cryptocurrency the future money?”  

Expect continued conversations about cryptocurrency regulation. Lawmakers in Washington D.C. and across the world are trying to figure out how to establish laws and guidelines to make cryptocurrency safer for investors and less appealing to cybercriminals. 

“Regulation is probably one of the biggest overhangs in the crypto industry globally,” says Jeffrey Wang, head of the Americas at Amber Group, a Canada-based crypto finance firm. “We would very much welcome clear regulation.”

China announced in September that all cryptocurrency transactions in the country are illegal, effectively putting the brakes on any crypto-related activities within Chinese borders. In the U.S., things are less clear. Federal Reserve Chair Jerome Powell said recently that he has “no intention” of banning cryptocurrency in the U.S while Security and Exchange Commission Chairman Gary Gensler has consistently commented on both his own agency’s and the Commodity Futures Trading Commission’s role in policing the industry.  

Gensler recently went so far as to say investors are “likely to get hurt” if stricter regulation is not introduced. Plus, the IRS has an obvious interest in making sure investors know how to report virtual currency when they file their taxes. Gensler’s and Powell’s comments are consistent with an emerging view among the Biden administration and other U.S. lawmakers that more cryptocurrency regulation is needed.

Like most things with cryptocurrency, regulation comes with hurdles. “There are different agencies that may or may not have jurisdiction to oversee everything,” says Wang. “And it differs state by state.”

Clear regulation would mean the removal of a “significant roadblock for cryptocurrency,” says Wang, since U.S. firms and investors are operating without clear guidelines at the moment.

What new regulation could mean for investors

The $1.2 trillion bipartisan infrastructure bill signed by the president in November includes crypto tax reporting provisions that could make it easier for the IRS to track crypto activity among Americans. Even before the new legislation, that’s why experts say investors should keep records of any capital gains or losses on their crypto assets. The new rules may also make it easier for investors to properly report crypto transactions. 

“Exchanges will have to issue 1099-B tax forms with cost basis information to investors,” Shehan Chandrasekera, CPA, head of tax strategy at CoinTracker.io, a crypto tax software company, recently told NextAdvisor. “This will significantly reduce the crypto tax filing burden.” 

Regulatory announcements can also affect the price of cryptocurrency in already volatile markets. Market volatility is why investing experts recommend keeping any cryptocurrency investments to less than 5% of your total portfolio and never invest anything you’re not OK with losing. 

Ultimately, many experts believe regulation is a good thing for the industry. “Sensible regulation is a win for everyone,” says Ben Weiss, CEO and cofounder of CoinFlip, a cryptocurrency buying platform and crypto ATM network. “It gives people more confidence in crypto, but I think it’s something we have to take our time on and we have to get it right.” 

Crypto ETF Approval

There’s already been a major breakthrough on this front, with the first Bitcoin ETF making its debut on the New York Stock Exchange in October. The development represents a new and more conventional way to invest in crypto. The BITO Bitcoin ETF allows investors to buy in on cryptocurrency directly from traditional investment brokerages they may already have accounts with, like Fidelity or Vanguard. 

“We do it in the equity market, we do it in the bond markets, people might want it here,” Gensler said at the Aspen Security Forum over the summer.

But some say the BITO ETF is not enough, because while the fund is linked to Bitcoin, it does not actually hold the crypto directly. The fund instead holds Bitcoin futures contracts. While Bitcoin futures follow the general trends of the actual crypto, experts say it may not track the price of Bitcoin directly. For now, investors must continue waiting for an ETF that holds Bitcoin directly.  

ETF approval has been in consideration by the SEC multiple times over the past few years, but BITO is the first to gain approval. 

What a crypto ETF means for investors

It’s too soon to tell how many investors will get in on BITO — but the fund did see lots of trading action in its first weeks. In general, the more accessible cryptocurrency assets are within traditional investment products, the more Americans could buy in and influence the crypto market. Instead of learning to navigate a cryptocurrency exchange to trade your digital assets, you can add crypto to your portfolio directly from the same brokerage with which you already have a retirement or other traditional investment account. 

However, investing in a crypto ETF, like BITO, still carries the same risk as any crypto investment. It’s still a speculative and volatile investment. If you’re not willing to lose the money you put into crypto by purchasing on an exchange, then you shouldn’t put it in a crypto fund either. Carefully consider if you’re willing to take on the risk of having cryptocurrency in your portfolio at all.

Broader Institutional Cryptocurrency Adoption

Mainstream companies across multiple industries took interest — and in some cases themselves invested in — cryptocurrency and blockchain in 2021. AMC, for example, recently announced it will be able to accept Bitcoin payments by the end of this year. Fintech companies like PayPal and Square are also betting on crypto by allowing users to buy on their platforms. Tesla continues to go back and forth on its acceptance of Bitcoin payments, though the company holds billions in crypto assets. Experts predict more and more of this buy-in. 

“We’ve seen a tremendous amount of inflow of attention, and that’s going to continue to drive the growth of the industry for a while now,” says Abner. 

Some experts predict bigger, global corporations could jumpstart this adoption even more in the latter half of this year. “What we’re looking at is institutions getting involved in crypto, whether it’s Amazon or the big banks,” says Weiss. A huge retailer like Amazon could “create a chain reaction of others accepting it,” and would “add a lot of credibility.”

Indeed, Amazon has recently sparked rumors that it’s making moves to that end by sharing a job posting for a “digital currency and blockchain product lead.” Walmart is also recruiting a crypto expert to oversee its blockchain strategy. 

What more institutional adoption means for investors

While paying for things in cryptocurrencies doesn’t make sense for most people right now, more retailers accepting payments might change that landscape in the future. It’ll likely be much longer before it’ll be a smart financial decision to spend Bitcoin on goods or services, but further institutional adoption could bring about more use-cases for everyday users, and in turn, have an impact on crypto prices. Nothing is guaranteed, but if you buy cryptocurrency as a long-term store of value, the more “real world” uses it has, the more likely demand and value will increase.  

Bitcoin’s Future Outlook

Bitcoin is a good indicator of the crypto market in general, because it’s the largest cryptocurrency by market cap and the rest of the market tends to follow its trends. 

Bitcoin’s price had a wild ride in 2021, and in November set another new all-time high price when it went over $68,000. This latest record high follows previous high points over $60,000 in April and October, as well as a summer drop to less than $30,000 in July. This volatility is a big part of why experts recommend keeping your crypto investments to less than 5% of your portfolio to begin with. 

But how high will Bitcoin go? Plenty of experts say it’s only a matter of when, not if, it Bitcoin hits $100,000. Bitcoin’s past may provide some clues as to what to expect looking forward, according to Kiana Danial, author of “Cryptocurrency Investing for Dummies.”

Danial says there have been plenty of huge spikes followed by pullbacks in Bitcoin’s price since 2011. “What I expect from Bitcoin is volatility short-term and growth long-term.”

What Bitcoin price volatility means for investors

Bitcoin’s volatility is more reason for investors to play a steady long game. If you’re buying for long-term growth potential, then don’t worry about short-term swings. The best thing you can do is not look at your cryptocurrency investment, or “set it and forget it.” As experts continue to tell us each time there’s a price swing — whether up or down — emotional reaction can cause investors to act rashly and make decisions that result in losses on their investment.

The Future of Cryptocurrency

We can speculate on what value cryptocurrency may have for investors in the coming months and years (and many will), but the reality is it’s still a new and speculative investment, without much history on which to base predictions. No matter what a given expert thinks or says, no one really knows. That’s why it’s important to only invest what you’re prepared to lose, and stick to more conventional investments for long-term wealth building. 

“If you were to wake one morning to find that crypto has been banned by the developed nations and it became worthless, would you be OK?” Frederick Stanield, a CFP with Lifewater Wealth Management in Atlanta, Georgia, told NextAdvisor recently. 

Keep your investments small, and never put crypto investments above any other financial goals like saving for retirement and paying off high interest debt. 

The Issue:

From barter, to the appearance of the Mesopotamian shekel 5,000 years ago, to gold coins, to the paper dollar, what constitutes money has evolved. Is the next step in that evolution the replacement of coins, paper bills and electronic accounts at commercial banks by cryptocurrencies like Bitcoin, Ethereum, Libra and Dogecoin? There are ongoing concerns about the volatility of the price of cryptocurrencies, their use for illegal and illicit transactions, their environmental impact, and the potential they pose for disrupting financial systems. What do we know about the actual and potential benefits and costs of cryptocurrencies to their users, and to society at large?

The volatility of cryptocurrencies have made them thus far a poor medium of exchange. Their main attraction is as a speculative asset.

The Facts:

Interest in Bitcoin took off in the wake of the financial crisis when trust in governments, central banks, and in big private banks was very low. The cryptocurrency “revolution” began in 2008 with a link to a nine-page proposal that laid out the details on Bitcoin in a cryptography mailing list. Bitcoin promised to provide a medium of exchange that would allow two parties to conduct financial transactions just using anonymized digital identities without using central bank cash or using a trusted financial intermediary like a bank or credit card company. Bitcoin tries to replace trust in a public institution with trust that is created through a public consensus mechanism; all transactions are posted on public ledgers that are maintained on multiple computers and visible to the entire community of Bitcoin users who can agree that a transaction is valid and if not reject it. 

Cryptocurrencies exist outside of government control and operate outside of traditional financial institutions. Conventional currencies are no longer backed by precious metals, but governments support their use by accepting them for payment of taxes. These currencies need not be physical bills or coins – recently, there has been interest in Central Bank Digital Currencies (CBDCs), a digital replacement for physical currency notes and coins. To date, five countries have introduced or commenced trials of CBDCs and 81 countries are exploring the possibility. A key distinction between CBDCs and cryptocurrencies is that the former is issued by a central bank and it is backed by the full faith and credit of the government while cryptocurrencies are not backed by any government but are set up and managed by an algorithm. Ultimately, the viability of a currency depends upon trust – people trust that others will accept it for payment, a situation that requires that the currency does not lose value quickly (as would happen in a hyperinflation). Whereas the trust in the viability of a conventional currency or a CBDC comes through the backing of a government, the trust in the viability of the cryptocurrency comes through its publicly observable distributed ledger that shows the history of its transactions.  

An important role of any money is to serve as a means to purchase things – a medium of exchange. Cryptocurrencies are proving to be a very poor medium of exchange. A currency will not be an attractive medium of exchange if its value is volatile since that means the number of units of currency needed to purchase a given item varies a lot. The original 2008 blog post that introduced cryptocurrencies by someone using the name Satoshi Nakamoto focused on the medium of exchange role, stating “I’ve been working on a new electronic cash system that’s fully peer to peer with no trusted third party.” But cryptocurrency prices have shown great volatility (see chart). The sharp swings can be more dramatic than apparent from looking at the price swings in Bitcoin overt the course of a year: On a single day in May 2021, for instance, the price of Bitcoin plummeted 30% and recovered to be down 12% at the end of the day. These large price movements make cryptocurrencies an undesirable way to pay for goods or services. Additionally, cryptocurrencies are expensive and cumbersome to use, and transactions are slow to be validated.  

Cryptocurrencies like Bitcoin and Ethereum have been an attractive way to purchase illegal or illicit goods and services but are becoming less so. The main attraction for the use of cryptocurrencies in illegal or illicit transactions is the anonymity they afford the buyer and seller who can use pseudonyms. But it is possible to uncover the identity of people who use Bitcoin or Ethereum for many transactions or for transactions involving real goods and services. Some new cryptocurrencies like Monero and Zcash are trying to offer more anonymity with more sophisticated masking technologies but these are difficult to use because they have complex user interfaces.

Currently, the main legal attraction of cryptocurrencies is as a speculative asset, but, as such, there are concerns about systemic effects on financial stability. People who gamble on Bitcoin likely know the risks, given that its volatility is widely known. It is possible that if these people lose money there may be no effects throughout the financial system. But there are concerns about price manipulation of cryptocurrencies, which raises the issue of fraud. There are also concerns that a collapse of the market for all cryptocurrencies, which now have a market value of well over $2 trillion, could spill over to the conventional financial system. 

The way in which Bitcoin is set up demands huge amounts of electricity, giving rise to adverse environmental consequences. People earn newly-minted cryptocurrencies through “mining” which involves competing with many other miners and using brute force computing power to be the first one to solve complex computational math problems. Validating a single Bitcoin transaction is estimated to be equivalent to the power consumption of an average U.S. household for a month. Bitcoin alone accounts for 0.4% of the world’s total electricity consumption and 60-70% of all cryptocurrency costs are electricity costs. While some claim that Bitcoin is more renewable-driven than other large-scale industries, a 2020 report from the University of Cambridge refutes this, stating that only 39% of energy consumed by mining facilities comes from renewable sources. There are other cryptocurrencies like Ethereum that are moving towards different consensus mechanisms, which are the ways in which the network of computers validate transactions. These new mechanisms will allow transactions to be processed more efficiently without the associated environmental problem.

What this Means:

Cryptocurrencies have captured the public imagination, but perhaps not in the way intended. In their present form, they are not viable mediums of exchange. The anonymity they ostensibly provide make them attractive for illegal and illicit transactions, but this is not a desirable end from a societal perspective. Currently, the main attraction of cryptocurrencies is as a speculative asset, although one that exhibits a great deal of volatility. There are also concerns about the environmental consequences due to the huge electrical demands of the mining of cryptocurrencies as currently configured. While technological improvements may improve the ease of using central bank digital currencies for both domestic and international payments – and there is a lot of demand for better, cheaper, and lower cost services, especially for those without a credit or debit card or a bank account – it is less clear that privately-issued cryptocurrencies could fill a useful role as a medium of exchange.